Planning for kids’ education after high school is extremely tricky. If you try to start young to get ahead of the expenses, you’re planning for something 10-15+ years in the future with lots of big unknowns. Many of these questions are about the individual child: what will interest them and what will they want to pursue at that point? Many are on the broader picture: how much is it going to cost by then, and is our current college model even sustainable with the incredible amounts of student debt we see now? The current situation with COVID-19 seems to be shaking things up even more. With colleges offering online options and all the uncertainty surrounding schools starting up in the fall, many people are evaluating the costs and whether or not the options they’re being offered are really worth the money. This topic is obviously very important financially, but it also brings many personal beliefs into the equation, along with the broader economics at play. So, what things do we need to consider as we work towards building a plan for future education costs?
Personal Feelings on Education Funding
This is the first place to start because saving for kids’ education can have a huge impact on our own finances, and people have wildly different opinions on how they want to handle it. Some people have no plans (or the means) to financially support their kids’ education after high school, while others are so passionate about it that the education savings are coming at the expense of other goals like retirement savings. Most people fall somewhere between those two extremes, but you need to iron out your personal feelings before moving much further. If you’re on the end of not prioritizing child college expenses, I think there’s still plenty of room for planning and guidance. For the most part, it’s hard for a 17-year-old to fully grasp the implications of a financial decision like this, so helping them understand the pros and cons of everything is important. On the other side, it’s important to make sure you aren’t over-saving for education in a way that can harm your own finances. Loans can always be taken out to help pay for college, but you can’t get a loan to pay for your retirement.
For families that want to help their kids through college, but maybe not commit to covering 100%, it’s important to break down the different factors and then plan from there. The number of kids you’re saving for is step one, it might be possible to put one through college, but three could be a different story. After that it’s important to consider how much, and what type of education you’re willing to cover. Some people want to plan for the first two years as a baseline, or maybe most of a four-year degree and nothing further. The types of schools we commonly consider have huge variances in tuition costs: in-state public universities, out of state universities and private schools. Depending on the particular child’s interests and readiness, community colleges or learning a trade can be a great way to learn and explore without blowing through a ton of money on something they’re unsure about.
Options for Saving
Once you’ve decided on a general plan and come up with goals, it’s time to figure out how to implement it. It’s important to evaluate all the benefits and drawbacks of different savings options, but for most people a 529 plan ends up being the primary savings vehicle to consider. These plans can help you to accumulate substantial assets if you start early and allow tax-free growth and withdrawals if used for qualified education expenses. Every state has its own 529 plan (sometimes more than one) that have unique features. Iowa’s ‘College Savings Iowa’ plan is good option, and while it doesn’t have a huge variety of investment options, it uses quality funds with low fees. Iowa also gives a tax deduction on contributions, which is $3,439 per contributor per beneficiary for 2020. This means if a married couple with two kids wanted to take full advantage, they could get up to a $13,756 tax deduction for their Iowa taxes this year. The main thing to keep in mind with 529 plans is that withdrawals are only tax free if used for qualified education expenses. While this definition was expanded as part of the SECURE Act, it’s still important not to over-save in a 529 because withdrawals can be subject to a 10% penalty on the earnings if not used for qualified expenses.
Outside of 529 plans there are plenty of other options to consider for education expenses, some better than others. Some people will talk about using a Roth IRA for this, but that isn’t really what it’s for and I’m not a big fan of raiding retirement accounts for other purposes. If someone is pitching you on whole life insurance as a college savings plan, run away! I like the simplicity of using a plain taxable investment account for any funds you want to save above the 529. While the growth on these will be subject to capital gains tax, it comes with no strings attached as far as penalties or qualified withdrawals. This means if it doesn’t end up being needed for education you can use it for anything else. Another option that isn’t savings based is to plan to use some of your normal cash flow during the college years to help cover expenses. This allows you to save for other goals now to make sure they’re on track, and the years when kids are in college are typically getting towards the highest earning years for a lot of families.
What Does the Future Look Like?
Similar to healthcare, I feel that the future of post-secondary education is extremely murky. Expenses can’t continue to climb by 8% annually or eventually almost everyone will be priced out. Will online learning become the dominant form of education or will the university system adapt in some way that enables the standard 4-year education to be affordable? While it’s important to plan for the system we have in place now, maintaining flexibility will be important for any changes that happen over time.
Involve your kids! Once they’re old enough to start thinking about their future plans and evaluating what that could look like, they need to be aware of all the different factors. One part of that is taking advantage of any opportunities for credit or experience they have available while in high school. No matter which direction they go, reducing the amount of time needed to complete the education goes a long way in saving costs. If you need help thinking through options for your kids, or have student loans yourself, schedule a meeting to talk through what options you might have.