Did you know that the average college student racks up a whopping $37,172 in student loan debt by the time they cross their tassel on graduation day? And the burden doesn’t stop there. This is simply the average, which means that it is not uncommon to see debt burdens of more than double this shackled to the ankles of your child during a time period in which they are just entering “the real world” where building wealth does not get any easier for them. It’s like starting the race of life a mile behind the actual start line. They are losing the race before it’s even begun. To make matters worse, the average trend line of tuition increases is currently at about 8% per year. At an 8% inflation rate that means that the cost of college tuition will double in the next nine years!
As parents what can we do about this? How can we help give our kids a fighting chance when we ourselves are struggling to get out of the rat race and achieve financial freedom? It’s understandable to see that saving for your children’s college fund makes the list of 7 steps to financial freedom and finds its rightful place in step 5. Helping your children have a fighting chance for their own financial freedom out of the gate is vitally important, however I know it seems like such a tall mountain to climb. And, your right, step 5 is not easy, but just like the steps before this, with hard work, careful planning, and the right financial vehicles it’s possible. Below are three 3 tax-favored plans that you can use, and 5 tips your kids can use, to come out with that diploma debt-free!
All information below is current as of February 2020. And remember these are meant to be tips to point you in the right direction, as with all financial and tax information make sure that you seek a professional tax and financial advisor to help you navigate this.
1. Education Savings Account (ESA) or Education IRA.
These are incredible vehicles that allow you to save $2,000 (after tax) per year, per child. Not bad! The best thing is that your funds grow tax-free! Rates of growth can vary based on the market and investments in the account of course but typically you will earn a much higher rate of return than in a regular savings account. Also even though your yearly contributions are after tax contributions, you won’t have to pay any taxes when you withdraw the money to pay for education expenses
- There is a variety of ESA investment options
- Your money grows tax-free!
- There are income limits placed on eligibility to invest in and ESA
- You can only contribute up to $2,000 per year.
- Your student must use the funds by age 30.
2. 529 Plan.
529 plans are another great vehicle especially if you want or need to invest more for your student’s education or if you are outside of the income qualification limits of an ESA or Education IRA. 529 plans can also be more flexible because you can change the beneficiary to another family member so for you parent’s that have more than one child that your saving for this gives you the option to change from the your first born to your second born if your first decides that college isn’t the right option for him or her. Some 529 plans also give you the option to choose the funds you invest in through your account, and definitely be sure to find a plan that gives you this option. Some 529 plans will put constristions on your options or change your investment ratios based on the age of your child and you definitely want to stay clear of these plans.
- Higher contribution levels than an ESA or Education IRA
- For most plans there are
- 529 Plans also grow tax-free!
- Even though you have the option to transfer the funds to another child sometimes there can be restrictions on this so make sure you understand them before opening an account.
UTMA or UGMA (Uniform Transfer/Gift to Minors Act).
The bg difference between UTMA or UGMA accounts is that they are in your child’s name, not yours. As a parent you are simply the manager or custodian of that account until your kiddo reaches the age of 21 (18 for the UGMA). These accounts are much more flexible and can be used in any way much more like a savings account and don’t have to be used for college expenses only.
- Funds are flexible so they can be used for other things outside of college expenses.
- Because these funds are in your student’s name it is taxed at their tax rate which is often times significantly lower than you the parent.
- More flexibility also means more required diligence. Once your student is of legal age they can use these funds however they want so while it was meant entirely for college tuition a bad decision can instead have them blowing it on a sports car!
- Similar to an ESA or Education IRA the beneficiary cannot be changed.
Also keep in mind that this step involves your children’s future so get them involved in the process! These 5 simple things can relinquish some responsibility, create good financial habits, and take the sole burden of paying for college off your shoulders.
- Make sure they apply for scholarship. There are a ton of scholarship opportunities out there for all different scenarios and skill sets. With just a little bit of time investment you get free money that you don’t have to worry about paying back!
- Take advanced placement classes. Advanced Placement (AP) classes give high school students the opportunity to earn college credits while they’re still in high school. Every AP class taken in high school is one less class you’ll need to pay for in college. Advise your child to talk to their academic counselor for more information.
- Get a job while in High School. Sometimes with sports or extra curricular activities this isn’t always possible during the school year. However even a summer job helps! It helps with college and scholarship applications, and it helps to stash away savings while they are at home and don’t have as many expenses as the “real world”.
- Open a savings account. If your child is able to earn a little income during their high school years make sure to put it in a safe place that is at least earning a little interest.
- Save money instead of spending it. Whether it’s birthday’s or side jobs now is the time to teach your children the very same habits you have been forming yourself through these 7 steps to financial freedom. Teach them financial literacy, diligence and the importance of a budget!
Step 5 in the path to financial freedom is one of the most important and also one of the most impactful in strong stewardship with your finances because it’s affecting your financial freedom and your children’s. Not only is passing down the gift of a debt-free degree to your children extremely impactful to their own path to financial freedom, but leading them by example and incorporating them into the process is an incredible way to teach financial literacy and diligence.