Episode 3 - In this episode, Emily and Amanda discuss how to create a college savings plans. It can be overwhelming to think about your child growing up an going off to college but there is no time like the preset to start saving.
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Emily Agosto (00:08):
Welcome to Connecting the Dollars, a personal finance podcast. I'm Emily Agosto, a CPA and financial advisor.
Amanda Vaught (00:16):
And I'm Amanda Vaught attorney and financial advisor, both Emily and I are co-owners at Propel Financial Advisors.
Emily Agosto (00:25):
Propel Financial Advisors is an investment management and financial planning company. We are fee only fiduciaries and independent registered investment advisors. I'm based in Chicago and Amanda is in New York City, but we work with clients nationwide.
Amanda Vaught (00:40):
The purpose of our podcast is to explore personal finance topics, including budgeting, investing, behavioral finance, current events, and other helpful information. We also hope you'll get to know us along the way.
Emily Agosto (00:54):
Thanks for listening. Hi Amanda.
Amanda Vaught (01:00):
Hey, how's it going?
Emily Agosto (01:03):
Great. How are you?
Amanda Vaught (01:04):
I'm good. I'm excited to talk college savings today.
Emily Agosto (01:10):
Yeah, this is a really big topic. We've been hearing a lot from clients and friends and family that they're ready to start planning. So it's an important thing to hit on
Amanda Vaught (01:20):
Mm-Hmm yeah, I think this is a question we always get, but for whatever reason lately, we're getting it more often. And we were just talking about why is that? And so could be because kids are back in school full time for a lot of people. So now, you know, parents have been taxed a lot lately. But now they have some more mental capacity to work on some of these issues.
Emily Agosto (01:49):
Yeah. And now that we're kind of past this crisis phase of the pandemic, it's a little easier to start thinking long term again. Mm-Hmm
Amanda Vaught (01:57):
yeah. And this college is a huge expense for a lot of families and definitely deserves time and attention to come up with a great plan for what will work for your family.
Emily Agosto (02:12):
Yeah. So starting off, should it be a priority for everyone? What do you think about that?
Amanda Vaught (02:20):
Well, I think obviously for parents if your kids are getting older and you haven't started planning yet, I mean there's no time like the present. Yes. It's great to start doing this as soon as possible, but if you haven't done it yet, don't let that stop you from making a plan. You can start this also if you're planning to have kids, but you haven't haven't had kids yet. You could still open a 529, even if you haven't had a child yet. And then you can also pull in grandparents who can contribute to 529s or other college savings plans as well. So it's, it's really a family affair, if you will.
Emily Agosto (03:04):
Yes. It's a part of the whole financial plan. Yes. so in terms of savings for someone who has a young kid, but doesn't have any retirement savings, do you think they should focus on that first?
Amanda Vaught (03:21):
Yes. I think that's a great question because for people, with kids, at least for me personally, I know this happens to a lot of other people is once you have kids, you have a tendency to stop thinking about yourself. You start putting your kid before you, prioritize their needs and, and their college can feel more immediate than your own retirement, but planning for your own retirement and making sure that's all in order I would say is most important for most people. And then move on to the college savings because, for several reasons, one is your own retirement. There are no loans available for retirement. Like there are for college, right? And also at the end of the day, if you just don't have enough money to help your kids pay for college there is financial aid and, and other sources for children to pay for college.
Emily Agosto (04:23):
Yes. I agree. I think retirement should be at least slightly higher priority than college savings, but I know a lot of people do wanna set their kids up for success. And of course you can't blame them. You want the best for your kids. Right? Right. So if we dig a little deeper here, what are types of accounts that you can open and save specifically for college?
Amanda Vaught (04:46):
Well, you do have a lot of choices. I mentioned 529s earlier. I do just wanna say really quick before we get into the types of accounts is to a good thing you can do before deciding what account or how much to put in is to have a talk with your spouse or your ex spouse, or if you're a single parent to, you know, sit down and evaluate your own values around this, about how much you feel you should be helping your child to pay for college. Are you willing to pay for a public school? Are you willing to pay for a private school? How much you think of this responsibility your child should take on themselves, that type of thing, and, and try to get on the same page as much as possible with your spouse on this or ex-spouse, whatever the case may be.
Emily Agosto (05:36):
Amanda Vaught (05:37):
Yes. Yes. So once you establish that and get an idea of what you're willing to do and you know, there's always what you're willing to do or like to do versus what you're able to do. Those can obviously be in conflict depending on your financial situation. Sure. But assuming, you decide, for example, that you're willing to pay for your child to attend a public university, then you can look at different charts. I did a recent blog post on college savings and JP Morgan did an estimate of the current costs college. And then the current rate of inflation because the cost of college has been growing significantly every year.
Emily Agosto (06:25):
Yeah. And much faster than inflation.
Amanda Vaught (06:27):
Yeah. Much faster than inflation. And so they estimate that right now, if you have a newborn, the cost of a four year college education is going to be about $230,000 on average for a public college. Like your state school. Yeah. That includes tuition fees and room & board.
Emily Agosto (06:54):
That's, that's a lot of money. Yes.
Amanda Vaught (06:57):
It's very significant, right? $230,000. A lot of people hear that number and they say, wow how are you ever going to get to that? And then you look at private college and the average, private college is $526,000 for four years. So more than half a million dollars if you have a newborn is what you need to save to cover the cost of a four year education. Assuming your child can graduate in four years, which a lot of children have trouble doing. Yeah. so those it's, those are big numbers. They can be very scary. I think for some people they see numbers like that and they think, oh, this is not even possible. Should I? I shouldn't even try. Right. You know, but you know, these numbers can be scary, but if we break it down into monthly deposits and work from there, take advantage of the power of compounding, then you can get there or you can get close, obviously, depending if you have the means to make regular contributions.
Emily Agosto (08:07):
Yes. And you don't have to have a half a million dollars before the child starts college, you can continue to save while they're in school. Right. Right. I mean there's a couple years more there. Yeah.
Amanda Vaught (08:18):
If you you're able, right. So Emily, I know you ran some numbers on what it would look like. If you did a certain monthly deposit, how large you could grow an account over say the life of, I mean, not the life of your child, the yeah. Until you, your child's 18, right?
Emily Agosto (08:42):
Yeah. I ran a few numbers for a friend. He said that he was finally paying off his own student loan. He was paying $500 a month. And so he's going to have this $500 and thought, you know, maybe that's a good idea to start putting that $500 towards a 529 for his kid. So his child's about three years old right now. So they have 16, 15 years to save. And I plugged in, if you put in $500 a month and ran some numbers, if it's aggressively invested, versus if it's moderately invested, and both get him pretty close for a four year public school. So we do have calculators that can assume an average annual rate of return, kind of look at the historical markets and take into account the college inflation rate, as we said, is growing faster than the current savings inflation rate. And it just kind of makes it a little clearer, maybe a little easier to think about that. Okay. I had that $500 going to something else. I didn't need it for my budget. I'm good on retirement. So I'm just going to swap that $500 deposit to a 529.
Amanda Vaught (09:57):
Yeah. I think that's one great way that you could work it into your budget.
Emily Agosto (10:01):
So that example was in a 529 plan mm-hmm
Amanda Vaught (10:05):
And that was, I think assuming seven and a half percent return.
Emily Agosto (10:10):
Right? So in this aggressive portfolio, it's assuming a seven, just 7% return, which is maybe likely, I know we've seen a lot of strange things in the market over the past few years. So if you're invested aggressively, I think that percentage is doable. Mm-Hmm
Amanda Vaught (10:30):
Yeah. I mean the past several years, the return has been way higher. So we don't know the future obviously, but if we assume 7%, an average return, you know, one year you could have 10% the next year you could have five the next year you could have negative mm-hmm , you know, it, it evens out over time. I think one of the key things to point out here too, is that this is taking advantage of compounding. That is very, if you just put money away and leave it in cash, you're not going to get there. You really need to get an invested, get this compounding working for you. And like I said earlier, the earlier you start the better, because that's how the compounding works over time. You need as much time as you can.
Emily Agosto (11:17):
Right. And another good thing about a 529 plan that we've kind of been talking about a bit, is that, so the funds go in, they go in post tax. So there's not really a benefit upfront, but this money is going to grow and compound. And when you take it out to pay for college expenses, it's tax free. So that's a huge benefit mm-hmm
Amanda Vaught (11:39):
And the, the tax benefit upfront really depends on the state. I think it's 30 or 31 states offer you a discount on your state tax return, right. For the money going in. But yeah, when the money comes out, that's the federal tax benefit, which is really the significant one for most people. That's right. Yeah. So every state offers a 529 plan, whether or not you should use your state plan that you live in is, is really personal. So if you would like that discount on your state taxes can be to your advantage. It really depends because different states offer different types of plans with different investment options. Great.
Emily Agosto (12:21):
Yeah, Illinois, this is bright starts. I believe it's pretty easy to just I'm in Illinois. So we deal a lot with Midwestern states and is pretty easy to set up. I know that Danielle, our co-worker likes to recommend Missouri's plan because they use Vanguard funds and it's very simple. And so you are limited in what you can invest in, in a 5 29
Amanda Vaught (12:46):
Illinois. And at col I know Colorado just cuz we have a client in Colorado who uses it. And a couple of other states they do offer advisor led 529s where you do have access to a lot more investment choices oh. Than you do with certain just certain states. Like I'm in New York. So I used a New York one and it's very limited investment choices. They're just basic indexes. And you know, we can't give really investment advice on here, but for some people that works and for other people, a more active approach with more investment options can be to their advantage or more suitable for their goals and their risk tolerance.
Emily Agosto (13:27):
Right? Yeah. Those are very personal choices. So aside from the 529 plan, I know we are starting to get into some other kinds of accounts. Mm-Hmm The Coverdell is one that does provide a little bit more flexibility in what you can invest in, but you are limited in how much you can put into the account every year.
Amanda Vaught (13:51):
Right? The Coverdell is also known as an Education Savings Account or ESA. And for that it's $2,000 per year per child. So and yet there's also an income limit. So if you're married, the maximum income you can have is $220,000 per year. So if you make more than that, you cannot use the Coverdell
Emily Agosto (14:16):
Right. Yeah. That's the 2021 number. So it may increase little going forward, but probably not that much. Mm-Hmm
Amanda Vaught (14:26):
Yeah. Some people have the UGMA or UTMA accounts. These are not the best instruments to probably to use for college savings. But if you have them already established, you could use money from there. I think one thing to be aware of here is that the money in these accounts, once your child turns 18 or 21, depending on your state, the money in those accounts becomes your child's assets. And those have a different effect on your financial aid award. If it's a child asset rather than a parent asset, right. And then another option you could use is the Roth IRA. The Roth is great for your own retirement savings. So I would say this with caution, you know, you really need to have your own retirement ducks in order before you use what's in your Roth for your child's college.
Amanda Vaught (15:22):
But then also the Roth thing too, is that you have to be 59 and a half to take withdrawals from it. And so this is something that it's more for an older parent or even a grandparent, if a grandparent wants to help pay for the grandchild's college mm-hmm . And then another good account that is great to use for college is just your general brokerage account. This is a great catchall for all types of savings, not just your own retirement and general savings, but also for a college savings, you don't get the same tax advantages you do with the 5 29, the Roth or the ESA Coverdell account, but it does provide a lot more flexibility because there's no age requirements and there's no, you know, there's no requirement that you use the money for education. So if you know, you think your child's going to go to college and then they end up just not going or college is not for them. Then you don't have all your money tied up in an education account.
Emily Agosto (16:24):
So if you do not use the funds in your 529 or Coverdell accounts for qualified college expenses, their qualified educational expenses, you may lose your tax advantages and there may be those funds may be subject to penalties. So I just wanted to point that out there. And I think we're coming to the end here. So what are your final thoughts? How do you think we should meet these goals for college savings?
Amanda Vaught (16:53):
Well, I think the first step is to set the goal and then the second step is to just get started because I think inertia can really work against you. And a lot of these financial planning types of situations, and especially for college savings, you want to get started as early as possible. If you're overwhelmed by the choices or what to do, just get started. Open the 529 in your state start putting in whatever amount a month and that way you at least got it started. And then you can always do a phase two, just stop reassess, say, I need to make a better plan and then go from there. You can always call us. We help people figure out plans for college savings all the time. Mm-Hmm we're I think we're a great resource and just know, you know, you'll, you're going to get there eventually. I think if you just work on it.
Emily Agosto (17:47):
Yeah. Everyone's plan is different. Everyone's goals are different. So I think that's a really good idea to just put that out there, to get started somewhere and see where you can go.
Amanda Vaught (17:58):
Yeah. The only thing I wanted to to say also is that recently there's a book from Ron Lieber who writes the column in the New York Times, the personal finance column in his book, it's called "The Price You Pay for College." And that book is just a great information source on not just how to save for college, which is a lot of what we cover today. But especially if you have older kids in high school, he gives a lot of information on how colleges determine their price, how to get scholarships, how FAFSA works, how the CSS profile works, which is a relatively new financial aid form required by private colleges or at least new in terms of it wasn't in existence when I was in college. Yeah. Yeah. So I would, I would highly recommend that book also, not just for parents, but also for, for kids in high school, if they wanna understand what's what's going on. And I think we can put a link to that in the show notes. Yeah,
Emily Agosto (19:04):
Absolutely. Well, thanks, Amanda.
Amanda Vaught (19:07):
Yeah. Thanks Emily.
Speaker 3 (19:12):
For all links and resources mentioned today, head over to www.connectingthedollars.com. Thank you for listening.
Amanda Vaught (19:19):
This podcast is for informational and entertainment purposes only and should not be relied upon as a basis for investment decisions. This podcast does not engage in rendering legal, financial, other professional services.