Few expenses carry a heftier price tag than a college education. Getting an early start on saving is crucial.
SMI's executive editor Mark Biller discussed the best tax-advantaged approaches to building a robust college fund on yesterday's Faith & Finance program.
Click the play button below to listen. Scroll down for the transcript.
Faith & Finance with host Rob West airs each weekday morning on American Family Radio. A different version airs weekday afternoons on Moody Radio.
(More radio appearances by members of the SMI team are posted on our Resources page.)
Transcript
Rob West:
Today's parents have better ways to save for their kids' college than existed a generation ago. So are you making the most of your college savings program?
Hi, I'm Rob West. Mark Biller joins us today with the pros and cons of several college savings programs. Then it's onto your calls at 800-525-7000. Call right now: 800-525-7000.
This is Faith & Finance on American Family Radio — biblical wisdom for your financial decisions. (opening music ends)
Well, our guest — Mark Biller — is the executive editor at Sound Mind Investing, an underwriter of this program. Mark and his team have waded through the fine and print of the available programs for college savings so you don't have to!
Mark, great to have you with us today.
Mark Biller:
Hey, Rob. Good to be with you.
Rob West:
Why don't we give, why don't you give us an overview, to start, of the current landscape and what today's parents should expect.
Mark Biller:
Yeah, sure. So everybody knows that we've had a nasty bout of general inflation over the last three or four years or so. What a lot of people don't realize is the cost of higher education specifically has been rising at two to three times the general rate of inflation over the last few decades.
And that's a huge part of the reason why student debt has become so much more common than it used to be. So, a little over half of today's new college grads enter the real world with a diploma and an education loan, and the size of those average debt loads has roughly doubled over the last 15 years or so.
Now, in the article that we're discussing today, we've got a calculator that estimates what 70% of the four-year cost of an in-state public institution will be at different time intervals in the future. So you can see what it'll be five years from now, 10 years from now, 15 years from now, and so forth.
The numbers get a little jarring, honestly. As one example, if you've got 14 years before your child will head off to college, 70% of that four-year cost in 14 years is going to run just under $150,000.
Now, the only good news in that is if you start saving early, the monthly amount you would need to save to hit even that type of a lofty target is a lot lower than if you wait and start later.
So, following that example, if you have 14 years to save, a parent would need to save about $520 a month. But if they waited until their child was already 10 years old, when they started saving for college, they'd have to save about twice as much every month.
Now, obviously, not every parent is going to be able to pay 100% of those bills. But the point I'm trying to make here is saving for college can be a pretty daunting task. It definitely requires an all-hands-on-deck mentality, and you want to start as early as possible.
Rob West:
No doubt about it. And I'm assuming by "all hands on deck," you mean it's important to get the kids involved in the process too?
Mark Biller:
Oh, absolutely. The goal is we're trying to minimize their student-loan debt, and the earlier that they understand that whatever isn't covered is ultimately going to be their debt. So let them know that early on and then also let them know how they can contribute toward that cost.
There are lots of ways — they can contribute their own savings from summer jobs. Of course, scholarships, as you were saying, is a huge one, financial aid they might qualify for, and so on.
And, of course, the earlier you and they get started, the better. And so we think it's a great idea to start a college fund for each child, and then as the years go by, have your kids contribute to that as they get money for birthdays and holidays, they earn money working, and so forth. And there's really a dual goal being achieved here, Rob, right? We're trying to reduce or avoid the college debt, of course, but also at the same time we're training the kid that discipline savings is the best approach to meet future financial goals.
Rob West:
Yeah. Mark, you mentioned communicating with the kids, and perhaps doing that early. Someone encouraged me when my kids were young to when the appropriate time came, tell the kids, "Listen, here's the percent of the college tuition we're expecting you to pay, or here's the dollar amount we are going to have for you. Now, you are welcome to go out on the web, and it's very easy to find the cost of attendance for any school in the country, and go ahead and do that research so you know how short you're going to be depending upon where you want to go." Do you subscribe to that idea?
Mark Biller:
Yeah, I think it's a great idea. Of course, I think there's room for some flexibility in there, but it's better to set that expectation and then maybe make an allowance later on as you see, okay, has this kid turned into a really responsible 18-year-old and is the best opportunity a little bit different than what we've been communicating? Really easy to make adjustments in that direction — way better than the other extreme, which is you haven't communicated anything, and they have their expectations set in the clouds, and then you come in at the last minute and say, well, actually we can only afford X, Y, Z.
So I think it's really, it's probably impossible to over-communicate your intentions early on and set those expectations and really get their buy-in as early as possible.
Rob West:
Yeah, I think that's well said. All right, we're talking about this article at soundmindinvesting.org — Making the Most of Your College Savings Program. Mark, what programs have you all identified as the best for college savings these days?
Mark Biller:
Yeah, there are three of them where we'll spend most of our time. I think it's worth really quickly noting that there are some programs that have been really popular in the past, say, when I was saving for my own college, and we're not going to spend time on those. But I do want to mention them because some people still think these are good ways to go. Those include EE savings bonds, custodial accounts under the Uniform Gifts to Minors Act, and prepaid college plans. Those used to be good tools. We don't really think those are the best tools anymore. There are better ones.
Today, the three best tools are Coverdell Education Savings Accounts, Section 529 College Savings Plans, and surprisingly, we think Roth IRAs belong in that mix. We like all three because of the strong tax advantages. They do have varying degrees of flexibility, and we'll get into that, but of course, each of those has some unique pros and cons as well.
Rob West:
Yeah. We'll unpack these while Mark Biller is here today. Let's go ahead and go to the phones. By the way, if you have a question for Mark Biller today or a comment related to college, saving for college, or the markets in the economy, you can call right now — 800-525-7000.
Monty's in Virginia. Monty, I understand you have an experience in this area. Share what happened with you.
Caller:
Well, I'll try to be very brief because I tend to talk too long, but the schools, for example, when you go to a private high school, 9-through-12 — there are schools like an elite here in Virginia in Madison County called Woodbury Forest. They charge at least $67,000 a year and it's only about 400 students.
Just to briefly tell you this, my children —because of my disability and being a veteran — my wife with our eight children qualified them for about 1-and-a-quarter million dollars to go to this expensive elite school.
Rob West:
Yeah, well, I think that's well said. Thank you for your service to our country, Monty. And I think he brings up a great point, Mark, and that is that not only are there just general scholarships out there that every student should apply for, but there are some very specific scholarships and grants depending upon your background, your ethnicity, your area of focus that you're looking to study, and a whole host of others, right?
Mark Biller:
Yeah, there really are. And of course these days you've got all that at your fingertips anytime you can get on the internet. So, a lot of it really is elbow grease and finding the sources where they detail a lot of these less publicized scholarships. A lot of institutions have their own stuff, too. So there's kind of the general pool that's available to everybody, and then the specific institution likely has some scholarships and different opportunities in financial aid as well.
Rob West:
Mark, before we head back to the phones, let's start with the first savings plan you mentioned, and that is the Coverdell Education Savings Account. I guess formerly that's the old "education IRA," right?
Mark Biller:
Yeah, that's exactly right. And with both the Coverdell and the 529 plans, these are specifically designed for college savers. They let you invest for college and then take all of the money, including the earnings, out tax free as long as you're using it for qualified education expenses.
With the Coverdell ESA, specifically, they're a compelling option for parents who have income under the limits that allow them to make contributions. And that income limit is about $190,000 for a couple married filing jointly. Now above that level, you're not allowed to contribute to a Coverdell. So that's kind of the first hangup with cover else for some people.
The main thing that we like about Coverdells over 529 plans is their flexibility. So with a Coverdell, you get to choose the specific investments that you want and you can make investment changes as often as you'd like to. Now not surprisingly, that type of flexibility is especially appealing to people like SMI members who like to direct their own investments and make changes because they can use our strategies in their college-saving plan.
Now, if you're a person that's just going to invest in an index fund, you don't really need that type of flexibility, so that may not be as big a deal for those folks.
Now, the main disadvantages of the Coverdell, like I mentioned, are there's an income limit on who's allowed to contribute, and you can only contribute a maximum of $2,000 a year per child. Now if you start early, like we've been saying, 2000 a year can definitely add up, but if you have to save quite a bit of money in a shorter period of time, that $2,000 a year limit is going to be quite a handicap.
Rob West:
Now, the greater flexibility of investment options that you just mentioned is clearly attractive, and it's one of the features of that Coverdell, or at least for some investors.
Share the details on the 529 plan.
Mark Biller:
So the 529 plan has really become the savings vehicle of choice for most families, and that's largely because a lot of people don't have that much riding on being able to change the investments. They just want to park it in an S&P 500 index fund or something like that. And for those folks, a 529 plan is going to be a great choice.
Now, the first thing you need to know about 529 plans is most of them are sponsored by individual states, but you don't have to be a resident of the state whose plan that you use, and you also don't have to go to college in the state of the plan that you use.
And what that means, Rob, is for most people, there are more than 50 of these plans sponsored by the different states — because some states actually have more than one — and you can shop among just about all of those. Now, the main thing that you want to look for, though, is some of these state plans do offer benefits, tax benefits on the contributions for people who live in the state.
So what all this means is you really want to look at your own state plan first, see if there's any kind of a tax break for contributions to your own state plan. If there is, then that's a pretty easy decision. You're probably going to want to use your own state's plan. If there isn't, then you can shop among all of the state plans for one that you like.
The big advantage of the 529 plan: there's no income limit for the contributions. There's no maximum contribution limit for most plans, although some of the states have set really high limits. So what that means is 529 plans are really the natural choice for higher-income college savers.
They do tend to be a little more one-size-fits-all, but that can actually be a good thing for some savers because most of these plans have age-based tracks that will automatically adjust your investment allocations to be more aggressive when the child's young, less aggressive when they're older. So if you kind of want to do a hands-off thing, a 529 plan can be a really great choice.
And the financial aid handling for both 529 plans and Covdells is pretty favorable. It's a little different than with a Roth IRA. So that's something to tune into as well.
I know I'm throwing a ton of detail out there here, Rob, but all of these details are in the article that people can get online.
Rob West:
Yeah, very good. We're going to continue to unpack these. Let's go back to the phones — to Arkansas.
Eric, I know you had a question about whether or not the funds would still be available if the child doesn't go to college. Share that with us.
Caller:
Hey, so experience from my own four, only one of them finished college. I've got 10 grandkids and if I start contributing to a fund, I'm fine with them having the money even. But what happens if they start college and they go a year and they decide, "This isn't for me. What happens to the money?
Rob West:
Sure. Mark?
Mark Biller:
Yeah, Eric, people are going to think that you're a plant because you're giving me such a perfect segue to talk about the next option, which is the Roth IRA.
But before we get to that one with a 529 plan and with a Coverdell ESA, there are actually some protections built in there so you're able to change the beneficiary of the plan, and you can even change it — like you mentioned having grandkids — so you can change it between siblings and then you can also change that from a sibling to a grandchild. So there's some flexibility there.
Just recently, a provision was added that actually allows somebody with 529 money when they graduate to roll that into a Roth IRA. So they're getting more flexible over time.
Rob West:
Yeah, that's exactly right. Well, the only other thing I'll mention is you can take 'em out on a pro-rata basis for [if you child or grandchild gets] scholarships and grants, so you don't have complete flexibility, but you do have some options.
Mark, we'll talk about the Roth IRA next. Stay with us.
Rob West:
Great to have you with us today on Faith & Finance here on American Family Radio. I'm Rob West. Mark Biller here today from Sound Mind Investing. We're talking college savings.
Before the break. Eric, who's still with us, called from Arkansas and wanted to know, "How do I get money out of a 529 or a Coverdell — one of these college savings vehicles you mentioned — if my grandchild goes to college and transfers out early, decides it's not for him or her, they don't go to college, what options do I have?"
Mark mentioned that you can change the beneficiary on these, Eric, so you could assign it to another grandchild. You can get it out on a pro-rata basis for scholarships and grants. You do have the ability now with the 529 to roll it into — up to $35,000, and it's going to be over time — roll the money that the beneficiary doesn't use into a Roth IRA in the beneficiary's name, the child. That would be a great start toward a retirement savings plan.
But if none of those are what you're looking for and you do take it out for non-qualified educational expenses, you will have federal income taxes on any of the earnings. You'll have a 10% penalty, and you may have a clawback if you got any state deductions or credits for 529 contributions.
And, Mark, that leads us then to this third option, which is investing in a Roth IRA from the very beginning, [but] specifically for college savings. That's something a lot of folks don't consider, right?
Mark Biller:
Yeah, it's definitely not usually listed as a college savings option because Roth IRAs are designed for retirement savings. But to Eric's points, they really can be useful under certain situations for college planning.
So here's the key with these. Roth contributions can be withdrawn for college expenses without any tax or penalty. So if you're 59½ or older when their withdrawals happen, you can actually take out any of the earnings tax-free, all that. But even if you're going to be younger than 59½, you can plan to be able to take out the Roth contributions and leave the earnings in the account for your own retirement.
Now, flexibility is the main reason why I really like this idea of using a Roth IRA because if Junior gets a big scholarship or decides they don't want to go to college, all of that money that you've been saving all these years is already going to be in the most tax-advantaged spot for your own retirement savings.
And that is trickier, like Eric's pointing out, if you've been saving in a Coverdell or a 529 plan. Now, of course, Roth IRAs do have some limits. Your income has to be below a certain threshold for you to be eligible to make Roth IRA contributions. The amount that you can contribute each year is limited, although most couples are going to be able to save [up to] $14,000 a year or more, and single parents [up to] $7,000 a year.
So the last point really, Rob, here is you can also save in a Roth IRA and then kind of double-up with a Coverdell or 529 plan account as well. So there are some ways to mix and match this and tailor it to your specific situation.
Rob West:
And just to be clear, so folks don't misunderstand, we're not talking about a Roth IRA in the child's name because they'd have to have earned income. So this is a Roth IRA in the name of the parent and spouse, or grandparent and spouse, but earmarked for the kids. The challenge here though, with Eric having 10 grandkids, is he's going to be limited in what he can save, right?
Mark Biller:
Sure, that's exactly right. But if you can start early again and you're putting in, say, $14,000 or so each year between you and a spouse, that can turn into quite a college savings pot to distribute among however many kids or grandkids down the road you might be distributing for.
Rob West:
Yeah. Very good. Eric, thanks for your call. And I understand you're a retired Marine. Thanks for your service to our country, sir.
Let's go to Texas. Vanee. Thank you for calling. Go ahead.
Caller:
Thank you for taking my call. Well, we live in a fallen world, and my comment is that if you have a student who abuses your sacrifice for the money that you have given them for college, such as dropping or failing classes or other misbehavior, you might want to go to a reimbursement plan where they have to pay for the classes upfront and then you reimburse. So if they make an A, you'll pay 100% of that class, a B 90%, C 80%, and if the course gets dropped or failed, that student has to pay for that class and sell with them. That's my comment on being the mother of five children.
Rob West:
I like it! Yeah, provide a little accountability there and some reward if they do well. What are your thoughts on that, Mark?
Mark Biller:
No, I love it. And, really, that kind of goes back to my comment towards the beginning of the program where I was saying even when you're setting up expectations when the kids are young, if you put in place what might sound like a hard line structure or hard caps on how much you're going to contribute, and then as the kid gets older, you can see, "Hey, this kid is really responsible. This kid is walking with the Lord. This kid is checking all the boxes the way I want them to," well, you always have the flexibility to adjust to that in a more lenient way, but it's really difficult to make things more stringent as you go along because they have their expectations set early.
So I think that's great. I think you can tailor a plan to your kids. You know them better than anybody, and so putting in some kind of accountability like that, that's beautiful.
Rob West:
Well, and that's going to come back to you because you're paying that on the front end for the A's, but you're going to get that back when they get those AP credits, or they get that scholarship, or something that is ultimately going to reduce the cost of college. So you actually may come out even though you're by incenting those good grades. But Venee, thank you for calling today and sharing your plan with us.
Mark, tie a bow on this portion of our conversation here today for college savings.
Mark Biller:
Yeah, so I think the main takeaway here, Rob, is that each of these plans has their own unique wrinkles. So it's worth taking a little time to go over them, maybe read this article and go back over these points. Whether you choose a Coverdell, 529, or a Roth — or some combination of the three — the big idea is that time is of the essence. Don't put it off. The earlier you make a decision and get started, the more you can get compounding working for you. So that's really the big picture takeaway today.
Rob West:
All right. Mark, quickly pivoting here in the next 90 seconds, before we need to let you go, to the markets and the Fed. Obviously, the Fed said they're going to take a "data-driven" approach. The data I guess is there based on what they've been looking for, which is why economists are projecting a nearly 100% chance of a Fed cut tomorrow. What are your thoughts on that and where the market's headed from here?
Mark Biller:
Yeah, always hard to say in the short term where it's headed. I'm optimistic. I really do think that this is a case where lower interest rates have the potential to kind of kickstart the big picture or big-ticket items like cars, houses, big-ticket items that people have been putting off financing because interest rates have been so high. So I think there is a chance that this could kind of reignite and extend this economic cycle as people are able to finance better with lower rates.
So I think there's some good reason for optimism here. And as you know, Rob, that's not always my default stance. So when I'm saying I'm optimistic, that's probably a good thing. But markets are already at all time highs, they're richly valued. So I wouldn't go crazy here thinking that everything is just going to be Goldilocks as far as the eye can see. But overall, I think it's good news.
Rob West:
Mark, always appreciate you, my friend. Thanks for stopping by.
Mark Biller:
Thank you, Rob. Appreciate the opportunity.
Rob West:
Folks, if you want to read this article we've been talking about on college savings, head to soundmindinvesting.org. sound mind investing.org. Back with your questions after this.
