Debt Free Living: Kids’ College

Note: If you don’t have kids, or they are grown and gone, you skip this step.

Everyone agrees that you should save for your kids’ college. Problem is, of course, that hardly anyone actually does it.

At my college, we called the kids whose parents had actually saved for college those rich kids. I want my kids to be those kids 😀

This is Baby Step 5. At this point, you’ve paid off all your debts (except the house), amassed an emergency fund, and started putting 15% of your gross income into retirement accounts. Now it’s time to start the college fund.

Think about how much easier it would have been for you to start your adult life without debt. Something like 2/3 of graduates have student loan debt.
I started to do some statistical research for this post, but I started crying so I had to stop.

My personal story is a little screwed up, but I’ve been telling you this whole time how I screwed up so why stop now. Basically, my dad was still an active alcoholic* and said, “Here, sign these papers so you can get scholarships.” So I did. Then he told me, “Okay, you’re going to get a refund check from school, and I need you to send that to me so I can pay for room and board because I am a responsible adult who knows how to do that sort of thing and you’re a 19 year old kid who’s never lived on his own.”

So I did. And yes, those were student loan papers he had me sign. Lesson learned: Read Everything, even when it’s someone you trust.

At the same time, he was telling my mom they needed to do a home equity loan in order to pay for my college. Oh, and did I mention that I had scholarships, so I didn’t actually need the loans? That’s why I didn’t question it. To this day, we have no idea where the money actually went. (Grad school was a different story, I totally signed up for that ride as a willing participant. I needed the money even less than when I was in undergrad.)

Now, just like with retirement you start where you are. To paraphrase Rumsfeld, you work with what you have, not what you wish you had. If your oldest is graduating next year, you’re not going to be in a position to send him to a private school on the other side of the country. If they’re still in diapers, you’re set. If your oldest is still a twinkle in your eye, you don’t start yet–move to Step 6 until you have kids.

lilwizard is coming in February. He’s our first, so we haven’t started Step 5 yet even though we know he’s coming. The vehicle you use for college savings is the Education Savings Account, or ESA. A maximum of $2,000 per year can go into this account. The inputs are after tax, and it grows tax free.

“Bah! That’s only $36,000! Tuition is going up every year! There is no way that will pay for college!”
Well, you’re right on all counts. Sort of.

True, you only put in $36,000 over an 18 year span, but with compound interest you’ll do very well. In fact, you’ll double to quadruple your money depending on the rate of return you get. So instead of having $36,000 on his 19th birthday, we’ll have between $70,000 and $130,000 for college. Tuition has been on the rise (about 7.9% per year for Tennessee public universities, lately), but that bubble is about to pop. When it does, we’ll go back to the times when people who went to college 1) wanted to be there and 2) worked hard enough to get there.

That’s one reason I don’t like prepaid tuition plans–it’s not exactly a liquid investment. You’re stuck in it at whatever the inflation rate is for tuition in whatever state you’re prepaying for. Here in Tennessee, you’d be stuck with a 7.85% rate of return when you could be making more in the open market. Another reason I don’t like prepaid plans is that The Board of Regents can just decide one day to not offer that plan anymore.

“What happens if I put all this money into an ESA and then my kid decides to be a traveling minstrel instead of the lawyer we planned on?”
Well, you can transfer the money to another family member or wait until he’s 30. At that point, he can get the money in the ESA but he’ll have to pay taxes on the gains.

Now, you don’t have to do an ESA…it’s just that there are tax advantages to doing so. You could put the money in a savings account that pays two cents a year for every ten dollars you have, or you could open a money market or a standard mutual fund and declare “this is for junior’s college” and that’s that. I recently advised a friend to pay off a rental house instead of contributing to an ESA and use the proceeds from the sale of the house to pay for college.

The important thing is that you SAVE FOR YOUR CHILDREN’S EDUCATION!
Your goal is for your kids to get made fun of because they’re not going to graduate with soul-crushing levels of debt!
*My father got sober about 5 years before he died. I rarely ever saw him drink. It was a total shock to me and my sister when he told us he was going to rehab. We always thought he was just an asshole. Turns out we had just never seen him sober. He’d been leaving work at 3pm every day for years and heading to the bar to drink until 6pm before coming home.