How do we plan for an educational expense that may or may not happen at some point in the future?
My fiancé and I are getting married soon and are planning to have children someday. A controversial question we are facing right now is this one: “Is it too early to start saving for college?”
Ask anyone about to get married, and they probably have saving for college near the bottom of their priority list. As a financial planner by day, however, my immediate gut response is that it is never too early to save for college! Especially with the costs of education rising as rapidly as 8% on average per year.
Well, how do we plan this –
1) For someone who we don’t even necessarily know will exist and…
2) For an amount of funding that is, and will remain for quite some time, undetermined.
3) And what if they don’t even go to college?
These three points don’t even come close to the kicker. The real underlying problem is this:
How do we save for our kids’ college while still saving for future expenses and retirement?
As a general rule, you don’t want to prioritize saving for your kids’ college over your own retirement. There are other ways to figure out paying for college when it hits. You can’t just instantly come up with retirement savings when it’s time!
Strategically speaking the goal should be to save for college in a manner that is flexible and not restrictive.
What do I mean by that?
Well, my future wife (and mother of said unborn children) and I may not want to lock up our money in an education-only asset, such as a 529 plan or Coverdell ESA. Granted, 529 plans are very effective for the purposes of saving for college; but what if we could save and invest somewhere that is tax-advantaged, like a 529 account, AND the funds could be used for anything we want? That would be especially prudent in case we are never blessed with children or if our children decide to pursue other opportunities besides college.
Flexible Investment Vehicles for Newlyweds
One option would be contributing to a Roth IRA as I explained in more detail in my last post. This can be a viable alternative to a 529 Plan and even better, can complement it.
Although there are IRS limits you must adhere to with the Roth IRA, it is virtually treated the same as a 529 Plan for federal income tax purposes, and after five years the funds can be distributed penalty and tax-free for college and/or retirement.
In fact, the Roth IRA is probably the first place I would start saving for the long term if one doesn’t already max it out each year. Why? It provides more flexibility and keeps the focus on retirement without sacrificing the ability to put that money toward college if necessary.
Cash Value Life Insurance
We could also invest in Cash Value Life Insurance (CVLI) that either my wife or I could own on our own lives. In addition to protecting the family from premature death (and potentially helping in the event of a disability or long-term care event), CVLI will build up cash on a tax-advantaged basis that can be withdrawn—using a policy loan—at any point in the future with no tax implications.
Two bonuses: It is not tied to the market and it doesn’t count as an asset when it comes time to apply for financial aid.
These types of policies can typically take several years to accumulate significant cash value and dividends, and so it would have to be a long-term savings strategy for the family. This is why I emphasize it now if you are in the process of getting married and/or starting a family. It is a good start for creating flexibility in the future.
Taxable Investment Accounts
Another option would be a taxable account that is invested in stocks, bonds, or mutual funds. I don’t love this option nearly as much as CVLI or the Roth IRA, since the gains in taxable accounts are taxed for long term capital gains (and in some cases for short term capital gains, which is worse!).
In fact, if you do a great job investing in the long term with these types of accounts, you are typically rewarded by having a larger and larger tax bill to pay each year! These accounts are also counted against you when you apply for financial aid.
These accounts, however, can pretty much be used for anything. This flexibility is especially helpful when you are young, starting a family, and planning to use the money before you retire.
I hope this blog was helpful as you plan wisely for the future. Please check out the rest of our website for more helpful information on college planning. I wish you the best of luck!
CFP, ChFC, CFBS, CLU, MBA