Baby DebtFreeJD is 6 months old. Perfect time to start saving for his college education.
Due to Mr. DebtFreeJD’s job we will (fingers crossed!) receive a pretty hefty discount on college tuition. HOWEVER! The estimated cost of four years at a public university in 2030 is $200,000+. That’s more than I paid to go to law school. Wowzers.
If we start putting money in an account for Baby DebtFreeJD’s college education now, we can take advantage of compound interest . . . aka the most powerful force in the universe. Mr. DebtFreeJD and I both got lots of help from our parents in going to our (expensive) colleges, and it’s important to us to be able to do the same for Baby DebtFreeJD.
I investigated the various possibilities for savings for college. In my mind, the serious* contenders were:
- A Uniform Transfers To Minors Act (“UTMA”) Account
- A 529 Plan
The UTMA Account
An UTMA account is pretty flexible. You can open one at your local bank or at a huge organization like Vanguard. It can hold pretty much any asset – cash, stocks, bonds, etc. The asset is held for your kid until he or she turns the age of majority in your state (that varies by state – usually 18 or 21). Once your kid is legally an adult, the money is permanently transferred to him or her. You don’t have any control over it. Put another way, if your kid wants to spend the money on booze and fast cars instead of tuition, there’s nothing you can do to stop him or her.**
The real downside to an UTMA account (in my opinion) is the way taxes work. Under the federal “kiddie tax,” the first $1,000 of earnings on the account are tax free. The second $1,000 are taxed at the kid’s tax rate (usually pretty low). But, any earnings above $2,100 are taxed at the parents’ rate.
Plus, having money in an UTMA account can have financial aid consequences. The money in an UTMA account (at least right now) is considered a child’s asset for financial aid purposes. By contrast, a 529 account is a parent’s asset. Colleges expect students to use all their own assets to pay for college, but are more lenient with parental assets.
The 529 Plan
This is named after a particular section of the tax code. It is a program established by a state or educational institution in which an individual investor can make contributions for the ” purpose of meeting the qualified higher education expenses of the designated beneficiary of the account.”*** In other words, it’s more limited than an UTMA account. The money must be used for a “qualified higher educational expense.” The IRS has explained what expenses qualify. These include:
- Tuition and fees
- Room and board (for students who are at least half-time)
- A computer
You can see a complete list here.
On the plus side, returns on your investments in a 529 plan grow tax free.**** Some states also let you deduct contributions to the plans from your state income taxes. A few (including ours!) even offer a small “scholarship” if you enroll in their state plan when your child is very young.
For me, that clinched it. We decided to open up a 529 plan in my name, listing Baby DebtFreeJD as the beneficiary. Then, after further research, we opened two 529 plans.
The Vanguard Plan
The first plan we opened up was at Vanguard. I love Vanguard, and have our taxable account, my retirement account, and my IRA there. I used the money we got from various generous friends and family members after Baby DebtFreeJD’s birth to make our contributions to that 529 account. I researched the fee expense ratios for each of the available funds. While normally my default would be to invest in a total stock market index (especially with such a long time horizon), the lowest fee expense ratio Vanguard offered was in something called the “Aggressive Growth Portfolio.” The fund is invested 60% in the Vanguard Institutional Total Stock Market Index Fund and 40% in the Vanguard Total International Stock Index Fund. Seems totally reasonable, especially since international stocks are now on sale!
Our State Plan
The second plan we opened up is run through our state. There, the lowest fee option was in a total US Equity Index. Perfect! We put 100% of our initial deposit into that. In addition, I set up the account to automatically deduct $100/month out of our checking account. I also filled out the needed paper work to get the matching “scholarship” contribution from our state, which amounts to $250.
Our state allows us to deduct up to $10,000 for joint fillers from our income taxes. I don’t think we’ll be contributing that much, at least at first, but we will remember to deduct our contributions come tax time next year!
We’ll want to rethink our asset allocation as Baby DebtFreeJD gets closer to college. However, I feel great that with 17 years or so left to go, we’ve started saving for one of the biggest and best future expenses he’ll have – a quality college education.
*Obviously, we could have just put money in a bank account, but that is clearly dumb.
**Other than hopefully having instilled values that buying new and fancy cars is a stupid use of money and that booze is best in moderation!
***Some states or educational institutions also offer “prepaid” tuition where you start paying tuition for a state school in the 529 plan. We wanted more flexibility than that.
****Caveat: Investment returns are definitely not taxable for federal income tax purposes. I ¿think? some states vary on this point, but ours definitely does not tax returns in its 529 plan.
DISCLAIMER: NOT LEGAL ADVICE, NOT FINANCIAL ADVICE. I FOUND ALL OF THIS OUT THROUGH GOOGLE, AND CERTAINLY COULD BE 100% WRONG. ALSO THINGS COULD HAVE CHANGED SINCE POSTING THIS.