Kids are the one thing all dads have in common. After that, it’s every dad for himself. In other words, what the dad of a newborn thinks and worries about isn’t the same things that the dad of a teenager thinks and worries about. Simply being a dad isn’t what defines a dad: it’s how old his kids are.
If we apply this thinking to finances—specifically, to saving for college—what’s a dad to do? When should you start saving? How much should you save? Matt Becker, a fee-only financial planner and the founder of Mom and Dad Money, encourages new parents to take a step back before diving right into college savings.
“Saving for college is a fantastic goal, but it may not be the most important,” Matt says. “I encourage my clients to spend some time thinking about what they want out of life. What are your personal goals? What are your values? When are you happiest? When you allow those personal preferences to guide your financial decisions, you’re more likely to get results that actually make you happy.”
Kam Amirzafari, AEP, CFP, a CERTIFIED FINANCIAL PLANNER professional with MacLean Wealth Management in Princeton, NJ, adds that having a handle on your current nancial situation allows you to make more informed decisions about where to put your money.
“You have to know: I have $50 a month extra, or I have $500 a month extra,” explains Kam. “From there, you can plan out your life. What I tell people is, when you know your salary is going to be X, you want to plan on saving ten to twenty percent, ideally around fifteen percent, automatically—and then figure out what mortgage you have, what car you’re going to buy, and all the other expenses. But people usually do it the other way.”
No one has ever explained it to me this way before. In fact, no one ever explained it to me at all. I’ve been living my life, then saving what’s left. Kam is saying the trick is to do it the other way: Save first, then live with what’s left.
Saving for college: where to start
Matt suggests that college isn’t the only goal. “For new parents especially, building a secure nancial foundation is at the top of the list of priorities. That means saving up some cash reserves, writing wills, and getting life and disability insurance. These aren’t the most exciting topics, but they ensure that your family will always have the financial resources it needs, no matter what.”
Kam stresses the importance of saving for retirement and other financial goals as well. “It’s about where you are in life. Is it cash reserve, is it college funding, is it for the next shore house you want to buy, that car you want to get? That’s the mentality you need to have about how to approach any financial decision. But the critical factor is that you need automatic savings, whether it’s your 401k or whatever.
“When you start to think about college funding,” he adds, “you have to decide what you want to fund. A state school. A private school. The very best school. You have to decide what level of funding you’re looking to do. I typically shoot for about half of what the funding should be because you never know where you’re going to be later in life, or if your child will get grants or scholarships or something. When you fully fund it, the money typically has to be used for education purposes, so try to leave it flexible.”
How much are we talking about, in hard dollars? “If you start saving early, when your child is a newborn” Kam says, “to fund a state school it’s about $350 per month at 8 percent. A private school’s about $850 per month at 8 percent.”
$350 a month? $850 a month? That sounds like a lot. Add a child to that equation, with all the costs that accompany parenthood, and it’s more than a little panic-making.
Link college and your mortgage
Kam suggests linking college funding and your mortgage in your mind—and the benefit makes it clear how outrageously smart this is.
“When a family comes to me with a newborn,” Kam explains, “what I say is, if you have a mortgage—and typically these things happen around the same time—let’s try to have your house paid off by making three extra principal payments every year. This will bring your mortgage down from thirty years to eighteen or nineteen years. That way, we free up your extra income during those college years. In other words, we’re saving and targeting your cash flow, which will be free because we’ll have your house paid off. And once it is, you have the flexibility to use that money for something else, such as college.”
For the second time in just a few minutes, I find myself wondering why no one ever told me this when my wife and I were just starting out. It would have been nice to know—because, really, it’s not a nice-to-know but a need-to-know.
529s: flex spending accounts for education
Does having a 529 plan make all of this easier? “The advantage of 529 plans is, the money grows deferred from taxes,” says Kam. “If you put in ten dollars and it grows to twenty, you can take that twenty bucks out tax-free for qualified secondary education expenses.” That’s college, not private grade schools.
But different states have different 529 regulations. “Some states offer an income tax deduction if you contribute to your home state’s plan,” Matt adds. “For example, New York offers up to a $5,000 income tax deduction for residents who contribute to New York’s 529 plan, and up to $10,000 for married couples.”
But, Matt adds, you don’t have to contribute to your own state’s 529 plan. “Many states don’t offer a tax deduction for contributions, and in those cases it makes sense to shop around for the plan that offers the best investment options at the lowest cost.”
Some states, like Pennsylvania, Arizona, and Kansas, offer tax deductions no matter which state plan you use.
What about grandparents? “Anyone can contribute to a 529 plan or even open one up themselves,” says Matt. “529 plans also have a special provision that allows you to contribute up to five times the annual gift exemption amount all at once without penalty. This allows you to save a lot of money and get some significant tax breaks.”
The annual gift allowance is currently $14,000, which means a grandparent can put up to $70,000 into each grandchild’s 529 accounts, and that money will grow tax-free. “Grandparents often have more money and they’re looking to reduce their estate, so they set up something for their grandkids,” Kam explains. “They fund their grandchild’s education and take it out of their estate to avoid estate taxes.”
Another advantage to 529 plans is their flexibility. “If one of your children doesn’t use it all,” Kam says, “you can change the beneficiary. So if you have multiple children, or if your kids don’t need it, you can switch it to yourself, your niece, your cousin, your grandkids.”
Matt adds that a 529 plan isn’t your only option. “Coverdell ESAs have stricter contribution limits but offer most of the tax advantages of 529 plans and can also be used for K-12 expenses. I also encourage people to consider regular investment accounts. You won’t get any special tax breaks, but the money is available for you to invest in your children in whatever ways you deem valuable, whether that’s college or something else.”
What are some of the best 529s? “Start by looking at your home state’s plan to see what tax incentives it offers,” Matt suggests. “If they aren’t attractive, look for an out-of-state plan with low fees and good investment options. New York, Utah, and Michigan all offer high-quality plans.”
To help with your research, savingforcollege.com has some great resources that allow you to compare 529 plans using a variety of factors.
Bottom line: set your goals early and save for them
“Decide what’s more important,” says Kam. “Some families choose to be in a smaller house so they can fund their kids’ private school and college. Some families do the opposite. Either way, you’ve got to plan your life.”
Matt encourages parents to “start by identifying the goals and values that are truly important to you. Then prioritize your money so that it’s going towards those things first, before your other expenses.
“The most important thing you can do is start saving, no matter what it’s going towards. Even small increases in your monthly savings can have a big impact when it comes to reaching your financial goals.”