Monday, January 04, 2010

Baby Step 5 – Kids College

I have to confess that we did not do a good job saving for our girl’s college fund. It can be attributed to not having a plan.

Sometimes, we try to do a little bit of everything and we end up not getting anything accomplished. This applies to life, relationships and money. I believe that this is why the Baby Steps have worked so well for us – it tells us that it is ok to wait until we are able.

Now that budgets are second nature, the debt is paid off, there is an emergency fund and retirement is taken care of, we can now move on to the next step: saving for the kid’s college.

DOC – Debt after College

Cindy and I have developed a mindset that debt did not bring us any blessings. We do not want our kids to graduate college and begin their lives with a big student loan. The average four year college student has a student loan debt of $19,237. Dave often quips on The Dave Ramsey Show that people keep their student loans for so long that it becomes a family pet.

We have begun speaking to our kids about college. Under our plan, we are aiming to pay for 75% of their in-state college expenses (living in the dorm, eating on the campus meal plan). The other 25% we expect them to earn. This can be a combination of scholarships and/or work. If they go on to graduate school, they will need to pay for that 100%.

Saving With Tax Favored Plans

There are several plans that you can save for your kids college. One is the Educational Savings Account (sometimes called an Education IRA).

In 2009, you can save $2000 per child after paying taxes. This means that the money will grow TAX FREE, and when you draw on it for college, you will not have to pay the taxes on the increase. If you have a child who is young, this is the best way to start.

If you have a shorter amount of time to save, you may want to consider certain types of 529 accounts. Certain types means that it leaves you in control of the mutual fund at all times (it does not freeze your options or automatically change investments based on the age of the child.

Functionally, the ESA and 529 are the same. However, all ESA operate the same while there are different flavors of 529, so be aware when you go shopping.

You don’t want to save using insurance, savings bonds ore pre-pay college. Each of these vehicles have poor interest rates as compared to the available mutual funds inside either the 529 or ESA.

Because Cindy and I started late, our ELP helped us set up a couple of 529 that we funded with money that we had been saving in a standard savings account.

How Much?

There is a worksheet in the FPU book for determining how much you will need to save for Kids College. This section is taken directly from that worksheet.

In order to have enough for college, you must aim at something. If you save at 12% and inflation is at 4%, then you are moving ahead of inflation at a net of 8% per year.

Step 1: In today’s dollars, the annual cost of the college of your choice is:

Amount per year


X 4 Years


Step 2: To achieve that college nest egg, you will save at 12%, netting 8% after inflation. So, we will target the nest egg using 8%.

Nest Egg Needed


Multiply by Factor


Monthly Savings Needed


The 8% Factors

Child’s Age Years to Save Factor
0 18 .002083
2 16 .002583
4 14 .003287
6 12 .004158
8 10 .005466
10 8 .007470
12 6 .010867
14 4 .017746

Your ELP Can Help You

When Cindy and I went to have our Roth IRA accounts established, we also set up the 529 for our girls. The ELP was able to do both tasks and it cost us nothing out of pocket.

Once again, time is the element that can give your savings muscle. Maybe you have more time than we had, so 100% savings may be a gift that you can offer. However, make sure that you are in the correct baby step. If you are in Baby Step 3, you can increase your cash flow by deferring your contributions.

When age appropriate, begin speaking to your children about college. My homeschooled girls were wondering if they even WOULD go to college.

I think they will thank you one day for not giving them a new family pet.

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