3 Steps for Successful Education Planning

Welcome back to We're Talking Money Short Takes. With education costs constantly on the rise, it's one of the largest growing concerns for all new parents. We hear the questions all the time: Where should I start? What should we do? There's got to be an easier way. We're going to tell them exactly what those ways are in steps one, two and three. Let's jump in.

Step one, keeping it simple: what's the goal? We have to have a place to start. We have to know what we're thinking about. We have to have a target to shoot for. Kind of like going on vacation, you start with where you're going and then you build backwards. We always have to start at one place. What's the vision? What is the goal? What are we trying to accomplish? Are we trying to cover 100 of college? Are we trying to cover 50 percent of college? Are we trying to have a set dollar amount aside?

Anything that you have is going to be extremely, extremely impactful. The more you do, the less likely your child is to come out of school with a lot of debt. And that's really what we're talking about here, is how do we get them through college without a lot of debt and the enormity of debt today.

But now we have to break down the math behind the goal. So we need to have an idea of what is it going to cost today, but what's it going to cost in the future? So for our example, we're assuming that your child, or our child, wants to go to a four-year university, state school in North Carolina. Let's just assume Chapel Hill. So Chapel Hill was 25 000 a year all in: tuition, books, extra fees, room and board. Hundred thousand dollars years for four years in today's dollars. That's the caveat.

So now we're looking at what the inflationary rate of college costs are growing by. Five percent is a nice safe number to use. And so if you plug it into your financial calculator, you just simply google time value of money, your education cost calculator, all of that will work. I'm going to use my financial calculator here. But so if we start with a hundred thousand dollars as our present value, that's the cost today, present value. We're gonna put five for our interest rate. We're gonna do 18 years, because let's assume that the baby was born now, we have 18 years till school. 18 years, our future value is going to be 240 000 that we need to save up. 100 000 today feels like 240. 18 years from now. 18 years. Okay.

So now we know our goal. Phil, what's the next step?

Well, if you need a quarter million dollars, after you pick yourself up off the floor, that's the next step, because that's a lot of money. You got to know which tools to use, because tax is going to be gnawing at you. That's certainly a factor. How you save, rate of return, all of those things are going to matter. So we got to get some interest on that money. You got to get some, you got to think more like an investor here. How do I get my money to work for me?

Let's talk about 529 to start. 529, probably the most recognizable, probably the most used, specifically for college. How it works is sometimes the contributions are tax deductible depending on the state. Most of them are not, but all 529 plans have tax-deferred growth. So you put the money in, it grows and grows and grows, you don't pay taxes every single year, and you get to pull the money out 100 tax free if used for those qualified education expenses.

But it shouldn't be where you put all of your money, and the reason why is if you don't end up needing the money, then there's some extra penalties and some taxes that are going to be associated. So if you have this money in the 529, let's say your child decides not to go, or they get a full ride even, or they start a business, or whatever the case may be, you just don't need the money. But you still want to have access, or you still want to get it out, but it's not going to be used for that secondary education, then you're going to pay a 10 penalty on all money distributed, and you're going to pay income taxes, federal and state, on any gains. And so the 520 is a great tool for a large chunk of education planning, but it shouldn't be the only tool that we use.

What about the second tool?

So, non-qualified brokerage account. Great place to save. You don't get the tax-free nature here that you do in the 529. On the other hand, you have full control. You can invest in anything you want. No taxation in terms of penalties when you pull the money out, and it doesn't matter if the child goes to college, doesn't matter about any of those things. The only thing you have to worry about in terms of tax is capital gain on the growth, and capital gain for most people is in that 15 range. Really, really low tax rate where you have full control. That's a little bit of a trade-off, but a great piece in addition to the 529.

I think the third one, though, maybe is the most powerful. It's your favorite tool. We talk about it all the time. It's the Roth IRA. It's not just for retirement, could actually be used for education.

So the Roth IRA, as you all may know, you put the money in after tax, grows tax-free, and you can pull it out tax-free for retirement. But one of the rules with the Roth IRA is any money that you put in, any contributions, you can take out tax free, penalty free, at any point in time.

So as you can see, there's lots of different options. There's lots of different tools in the toolbox. And one of the great things about using all these tools is now we're very flexible in whatever happens for the future.

So that brings us to step three: start saving. There's, that's all that you need to say about it, is you gotta start. You gotta start soon. So if you're a new parent or you're expecting, particularly those of you that are expecting, it's amazing how compound interest can change the outcome. Just five years of waiting means that you've got to save double what you would have to save had you started five years sooner.

Maybe you can't start with the 400. Maybe you can't start with whatever that amount is that you need, but you can start with something. Start with 50, start with 100. Put a little bit in the Roth, or a little bit in the 529, a little bit in the brokerage, whatever it is. That'll become a habit, and before you know it you'll be up to that 400, getting further and further down the road in less time.

The old saying, kick in the can down the road, happens throughout life. And so the more you delay it, the more likely you are to continue delaying it, so don't get stuck in that trap. Great tools, you got to know them, you got to use them, and you gotta start now. Don't delay.

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