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College Savings for Kids


rayfinkle
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I'm trying to develop a strategy for college savings for my son (~6 months old). We live in California, and I've done only the most basic research on college savings programs (529's, prepaid plans, etc.). Has anyone thought this through in general--or specifically in CA? The main thing I'm struggling with is reconciling the tax advantaged option, which is likely has limited investment options (e.g., a fidelity fund) vs. eating the tax bill now, and investing the funds myself--I've handily beat the benchmarks (luck? skill? TBD) for a good while now. I completely understand the math behind the compounding + tax implications, but am not as familiar with "creative" savings strategies...

 

Thanks!

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Here is an "odd" question for you...

 

Is college even going to be worth it in the distant future?

 

How much will it likely cost when your children are ready?  I know several people who are sending kids to school now and will be paying (borrowing) $100k+ for an undergraduate degree.

 

Would that money be better spent buying your children a business?  Income properties?  Something else?

 

Just something to consider...

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Here is an "odd" question for you...

 

Is college even going to be worth it in the distant future?

 

How much will it likely cost when your children are ready?  I know several people who are sending kids to school now and will be paying (borrowing) $100k+ for an undergraduate degree.

 

Would that money be better spent buying your children a business?  Income properties?  Something else?

 

Just something to consider...

 

These are all good points but its hard to put an exact value on college education. My belief is that you have do some things in life based on gut and common sense, not just ROI. Here's what a wise man said "Not everything that can be measured matters and not everything that matters can be measured"!

 

 

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How old are you?  If your child will be in college after your 59.5 birthday then you can take money out of a Roth tax-free including any earnings.  I never did any of these programs and my kids are approaching college age and I plan on funding from Roth contributions and current earnings.  I think the flexability was worth it for me as my son delayed college entrance for a year and is now doing a 2 & 2 with a local community college. 

 

Packer

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Here is an "odd" question for you...

 

Is college even going to be worth it in the distant future?

 

How much will it likely cost when your children are ready?  I know several people who are sending kids to school now and will be paying (borrowing) $100k+ for an undergraduate degree.

 

Would that money be better spent buying your children a business?  Income properties?  Something else?

 

Just something to consider...

 

I agree in theory, but my experience suggests that there are a limited number of schools that are worth paying for. I was lucky to get into one of these and the benefits will accrue for a lifetime. Without this experience I would have never left the state I grew up in, likely would have had fewer friends (and a more homogenious group of friends), and generally missed out on a ton of opportunities that I would not have known existed. I would love for my son to have this type of opportunity. Maybe it's not the best financial decision (meaning the ROI on college might not beat an arbitrary hurdle rate of return), but the intangibles are important.

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How old are you?  If your child will be in college after your 59.5 birthday then you can take money out of a Roth tax-free including any earnings.  I never did any of these programs and my kids are approaching college age and I plan on funding from Roth contributions and current earnings.  I think the flexability was worth it for me as my son delayed college entrance for a year and is now doing a 2 & 2 with a local community college. 

 

Packer

 

Packer, I'm leaning towards this approach too--I love the optionality. I'm 28.

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These are all good points but its hard to put an exact value on college education. My belief is that you have do some things in life based on gut and common sense, not just ROI. Here's what a wise man said "Not everything that can be measured matters and not everything that matters can be measured"!

 

I agree with you almost 100%!

 

Going away to a different city for my undergraduate education was one of the best things that ever happened to me.  I made several life long friends, had a great time, and learned many things.  At the time, the school was relatively inexpensive.  I managed to get out without borrowing any money, thanks to my parents contributions and my working & saving.

 

Graduate skool was a completely different thing though.  One of the WORST mistakes of my life.  I borrowed a significant amount of money to do it.  It turned the value of the degree was almost worthless and not at all what the skool represented it to be.

 

The point is, going to school can be a great thing IF the costs are relatively low.  If you are talking HUNDREDS of thousands of dollars...I'm not so sure...

 

College costs have been rising faster than inflation for decades.  18 years from now, could a relatively "average" undergraduate education wind up costing $250k in today's money?  I would not be surprised at all if it did.

 

Would it be worth spending $250k in today's money for an undergraduate diploma?  Hard question to answer...

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My opinion is that K12 is more important than college. One way to do it would be spend the money on high-quality K12, then send the kid to a European college, which would be much cheaper, but still good quality. :)

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For the education specific programs, what happens if you end up not having to pay for your kid's education? (bec. they decided not to go, or got a scholarship)

Will you have to pay some fine if you withdraw or use it for another purpose?

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I second DTEJ's comments, I went to a top undergrad school but the friendships were worth more than the tuition. At 18+ I think experience pays more than classroom lectures.

 

+1

 

Undergrad college education is mostly about the experience especially if you get there in late teens or early twenties. I went to the top school in my country too, tuition wasn't very expensive, but 10 years out, the only things I truly remember from that education are the "out of classroom" experiences and the lifelong friends I made there.

 

What is the ROI of that investment?

Even if the tuition were 100 times more expensive, I would do that trade over and over again. Without those experiences and friends, my life would be totally different.  Would I pay 250K for it in today's dollars? In a heartbeat, knowing what I know now. You can't make these decisions looking forward. Only when you look back at it, it makes sense.(paraphrasing Steve Jobs here)

 

Grad school is different. That decision should be mostly driven by ROI.

 

As far as the cost of average tuition goes, I don't think a fixed dollar amount for everyone is fair. Colleges should be paid in lifetime equity (kind of a tax on lifetime earnings). Colleges should be free to get into, and then depending on how well you do, that education should be proportionally expensive. Since most of the value of that education accrues in the intangibles like brand, experience and relationships, it should be worth different amounts to different people.

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My kids are 9 and 11 so further along the path than yours, we still have some time to save but college expenses have gone from being an abstract concept to a current concern...

 

I have Coverdell accounts for the kids but the contribution limits are not very hgih.  They used to be $500/year per kid but are now $2000/year per kid.  This is across all contributors, so if you and your in-laws each chip in $1000 per kid then it's maxed out.  With expected college costs in the $100-250k range per kid, this seems like a laughably low limit.  BTW these contributions aren't tax deductible like an IRA but the gains are tax free. This is one of the few tax breaks you'll get with college savings plans. The good news is that you have a lot of freedom how to invest this money basically any fund / brokerage / etc.

 

The 529 plans have changed somewhat over time.  It used to be that they were good only for colleges in your state, then that changed so you can use them in other states.  They have expanded the investment options, it used to be only a savings accounts and now there are various stock and bond options.  In Virginia where I live there is still a "prepaid" option where you can basically buy semesters of college today for presumably less than they'd cost when your kid is going to school, but the kid has to go to school in Virginia.  They also have a plan where the money is invested 90%+ in stocks when the kid is little and the balance shifts to 10% stocks and 90% bonds as they get near college age.  This sounds interesting on paper but with interest rates near zero I don't want any bond exposure over the long term, but that's just me.  Bottom line is that you need to read up on the details. I get a break from my state (not federal) tax for 529 contributions up to $4000/kid, my Virginia income tax rate is around 4-5% so this isn't a huge break but at least it's something.

 

I also have UTMA/UGMA accounts for the kids which I set up before I really understood them.  Basically the money is in their name / SSN and there is a small tax break, basically the first $1000 or so of income/gains in the account is tax free and the next $1000 or so is taxed at the kid's rate (presumably the minimum rate of 15%).  Not sure about those amounts today.  However to get this tax break the kid has to file their own tax return.  Depending on how you do that the costs associated with doing the tax return can largely offset the savings, for example you might pay $150 tax on $1000 but if you spend $100 to do the tax return you've only saved $50 and went through a lot of hassle. And if you think about it this tax break becomes relatively meaningless once the accounts get up to around $20k, i.e. if you have an account of $20k that has a 10% return or $2k, that is the extent of your tax break, if the account is $50k then the tax break is almost meaningless.

 

With UTMA/UGMA you are also stuck with the issue that the money is legally the kid's, so when they turn 18, they could take it and go tour with their favorite band for a year instead of going to college (slightly tongue in cheek but there is definitely a risk here), Fairmark has a good treatment of the topic:

 

http://fairmark.com/custacct/regret1.htm

 

The Gerber life savings plan that you see advertised on TV is really a savings plan, the return on investment is something like 1-4%, you'd be better off just putting your own money into an index fund or something.

 

If you will be age 59 or older when your kids go to school you might be able to withdraw from your IRA for qualified educational expenses, I haven't tracked this closely and this doesn't apply to me but is another option potentially worth considering.

 

So in short I haven't found any really satisfactory plans.  We max out the Coverdell ($2000/kid) and 529 ($4000/kid) each year and get the small tax break, I have stopped contributing to their UTMA/UGMA accounts, and besides that just figure I'll pull money out of my personal accounts when the time comes.

 

It's a real shame that the government doesn't provide more support for what must be one of the most important expenses for parents, kids, and society as a whole, even as costs are spiraling out of control.  $0.02.

 

http://imgur.com/5GvWV

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My kids are 9 and 11 so further along the path than yours, we still have some time to save but college expenses have gone from being an abstract concept to a current concern...

 

I have Coverdell accounts for the kids but the contribution limits are not very hgih.  They used to be $500/year per kid but are now $2000/year per kid.  This is across all contributors, so if you and your in-laws each chip in $1000 per kid then it's maxed out.  With expected college costs in the $100-250k range per kid, this seems like a laughably low limit.  BTW these contributions aren't tax deductible like an IRA but the gains are tax free. This is one of the few tax breaks you'll get with college savings plans. The good news is that you have a lot of freedom how to invest this money basically any fund / brokerage / etc.

 

The 529 plans have changed somewhat over time.  It used to be that they were good only for colleges in your state, then that changed so you can use them in other states.  They have expanded the investment options, it used to be only a savings accounts and now there are various stock and bond options.  In Virginia where I live there is still a "prepaid" option where you can basically buy semesters of college today for presumably less than they'd cost when your kid is going to school, but the kid has to go to school in Virginia.  They also have a plan where the money is invested 90%+ in stocks when the kid is little and the balance shifts to 10% stocks and 90% bonds as they get near college age.  This sounds interesting on paper but with interest rates near zero I don't want any bond exposure over the long term, but that's just me.  Bottom line is that you need to read up on the details. I get a break from my state (not federal) tax for 529 contributions up to $4000/kid, my Virginia income tax rate is around 4-5% so this isn't a huge break but at least it's something.

 

I also have UTMA/UGMA accounts for the kids which I set up before I really understood them.  Basically the money is in their name / SSN and there is a small tax break, basically the first $1000 or so of income/gains in the account is tax free and the next $1000 or so is taxed at the kid's rate (presumably the minimum rate of 15%).  Not sure about those amounts today.  However to get this tax break the kid has to file their own tax return.  Depending on how you do that the costs associated with doing the tax return can largely offset the savings, for example you might pay $150 tax on $1000 but if you spend $100 to do the tax return you've only saved $50 and went through a lot of hassle. And if you think about it this tax break becomes relatively meaningless once the accounts get up to around $20k, i.e. if you have an account of $20k that has a 10% return or $2k, that is the extent of your tax break, if the account is $50k then the tax break is almost meaningless.

 

With UTMA/UGMA you are also stuck with the issue that the money is legally the kid's, so when they turn 18, they could take it and go tour with their favorite band for a year instead of going to college (slightly tongue in cheek but there is definitely a risk here), Fairmark has a good treatment of the topic:

 

http://fairmark.com/custacct/regret1.htm

 

The Gerber life savings plan that you see advertised on TV is really a savings plan, the return on investment is something like 1-4%, you'd be better off just putting your own money into an index fund or something.

 

If you will be age 59 or older when your kids go to school you might be able to withdraw from your IRA for qualified educational expenses, I haven't tracked this closely and this doesn't apply to me but is another option potentially worth considering.

 

So in short I haven't found any really satisfactory plans.  We max out the Coverdell ($2000/kid) and 529 ($4000/kid) each year and get the small tax break, I have stopped contributing to their UTMA/UGMA accounts, and besides that just figure I'll pull money out of my personal accounts when the time comes.

 

It's a real shame that the government doesn't provide more support for what must be one of the most important expenses for parents, kids, and society as a whole, even as costs are spiraling out of control.  $0.02.

 

http://imgur.com/5GvWV

 

Thanks--this is great. I was slowly coming to a similar conclusion, but this helps a ton. I'm concluding that besides some marginal (small $$) tax benefits, the real boost is locking in future price today in states where that's available.

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My kids are 9 and 11 so further along the path than yours, we still have some time to save but college expenses have gone from being an abstract concept to a current concern...

 

I have Coverdell accounts for the kids but the contribution limits are not very hgih.  They used to be $500/year per kid but are now $2000/year per kid.  This is across all contributors, so if you and your in-laws each chip in $1000 per kid then it's maxed out.  With expected college costs in the $100-250k range per kid, this seems like a laughably low limit.  BTW these contributions aren't tax deductible like an IRA but the gains are tax free. This is one of the few tax breaks you'll get with college savings plans. The good news is that you have a lot of freedom how to invest this money basically any fund / brokerage / etc.

 

I also have Coverdell accounts for the kids, and they're nice.  Would be nice to have a higher contribution limit of course. They're great if you can hit it like Eric. :)  If opened at birth and you have reasonable returns you can still pay for a decent chunk out of it.  There are also interesting rollover rules for the accounts that would be really complex to take advantage of, but there's potential there.

 

The 529 plans have changed somewhat over time.  It used to be that they were good only for colleges in your state, then that changed so you can use them in other states.  They have expanded the investment options, it used to be only a savings accounts and now there are various stock and bond options.  In Virginia where I live there is still a "prepaid" option where you can basically buy semesters of college today for presumably less than they'd cost when your kid is going to school, but the kid has to go to school in Virginia.  They also have a plan where the money is invested 90%+ in stocks when the kid is little and the balance shifts to 10% stocks and 90% bonds as they get near college age.  This sounds interesting on paper but with interest rates near zero I don't want any bond exposure over the long term, but that's just me.  Bottom line is that you need to read up on the details. I get a break from my state (not federal) tax for 529 contributions up to $4000/kid, my Virginia income tax rate is around 4-5% so this isn't a huge break but at least it's something.

 

I really don't like the investment options so I've stayed away from the 529 plans.

 

I also have UTMA/UGMA accounts for the kids which I set up before I really understood them.  Basically the money is in their name / SSN and there is a small tax break, basically the first $1000 or so of income/gains in the account is tax free and the next $1000 or so is taxed at the kid's rate (presumably the minimum rate of 15%).  Not sure about those amounts today.  However to get this tax break the kid has to file their own tax return.  Depending on how you do that the costs associated with doing the tax return can largely offset the savings, for example you might pay $150 tax on $1000 but if you spend $100 to do the tax return you've only saved $50 and went through a lot of hassle. And if you think about it this tax break becomes relatively meaningless once the accounts get up to around $20k, i.e. if you have an account of $20k that has a 10% return or $2k, that is the extent of your tax break, if the account is $50k then the tax break is almost meaningless.

 

This is mostly true, though filing the taxes can be done very simply and cheaply if you're under that 2k limit, and you don't file taxes at all if you're under 1k (talking about capital gains only).  I also use these accounts but for a different reason--this is for money that I truly consider "theirs"-gifts from others, work income, etc.  I also use it as a teaching opportunity, so I match their savings elections, depending on age we talk about the account and how it works, investments, compounding, etc. I don't consider it savings for college at all, and I don't really contribute the accounts directly other than as noted.

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I have 529 accounts under Nevada's plan for my kids.  I think of 529s as more of a tax avoidance vehicle than as college savings plans - e.g. a place to hold high-yield bond funds and TIPS funds (both via Vanguard funds) so as to shield their distributions from tax.

 

Thanks,

Lance 

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I really don't like the investment options so I've stayed away from the 529 plans.

 

I agree, the "aggressive" plan I'm in is invested in VASGX, which is composed of 3 index funds including an international and bond fund neither of which I like.  I would rather just be in a stock index like the S&P 500 or Russell 2000.

 

It only takes a few percentage points of underperformance to offset the small state income tax benefit, so it might be easier to just put your own money into an index fund.

 

Again, it's really too bad that there are so few options and so little assistance for such a major expense...

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I really don't like the investment options so I've stayed away from the 529 plans.

It only takes a few percentage points of underperformance to offset the small state income tax benefit, so it might be easier to just put your own money into an index fund.

 

Isn't the major benefit that the gains are untaxed if used for qualifying expenses?

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