The Personal Finance Podcast - How to Save for College (The Smart Way!)

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Starting point is 00:01:40 college the smart way. If you have any questions, hit me up on Instagram at Master. Money Co. And hit me up on TikTok as well. You can ask me a question on TikTok and I'll answer you via video at Master Money Co as well. And follow us on Spotify, Apple Podcasts or whatever podcast player you love listening to this podcast to. And if you want to help out the show, leave a five star rating and review on Apple Podcasts or Spotify. And don't forget to check us out on YouTube as well. We are Master Money on YouTube. So today, we're going to be talking about how to save for college the smart way. And this is something we get a number of questions about. Well, how should I go about saving for my kids college? When should I go about saving for my kids' college? So today we're going to talk about a bunch of different college savings options.

Starting point is 00:02:32 In addition, I'm going to talk about a bunch of considerations that you should be thinking through as you're thinking through this process. We're also going to go through, hey, if I invest some of these dollars for college, how much will my money grow in 18 months, depending on how? much money I save each month. And then we're also going to have at the very end, we're going to talk about what to do if you actually started saving for college late. Because there's some additional things that you can do to get some grants and funding and things

Starting point is 00:02:58 like that so that you can reduce the load of college for your kids. Now, before we dive in, there's one thing I want to mention up front, is that this is a major thing that we talk about all the time. And if you haven't heard the stairway to wealth episode, we talk about this in that episode as well. But if you're not saving for retirement yet, you have no business saving. for your kids college. Do not start saving up for your kids college prior to saving for your own retirement. Now we call this the oxygen mask method. Why is it called the oxygen mask method? Because

Starting point is 00:03:26 when you're on an airplane and it needs to make a crash landing, what do they tell you to do first? You put your oxygen mask on first, then you help out others, whether it's your kids or the person next to you, whatever else it is. The same thing goes for your retirement. Do not start saving up for your kids college. Guess why? You want to know why? Because there's no loan. for retirement. There are loans for college. Now, is it a much better situation for your kids if they don't have loans? Absolutely. But you have to take care of your retirement first because you're going to be in a bad situation if you have zero retirement there. So knowing that there's no loan for retirement, you've got to go ahead and make sure you hit those retirement goals first,

Starting point is 00:04:04 then take care of your kids. This is why on the stairway to wealth, those future savings goals are the things that we talk about later on on the stairway to wealth. Now, if you don't know what the stairway to wealth is. It's an episode that we had. We talk about the order to put your money in. And as you guys have questions, we're always morphing in, adding things to the stairway to wealth.

Starting point is 00:04:23 So it's something that I would definitely check out that episode. I'll link it up in the show notes below so you can check it out. And make sure you understand the order to put your money in. Now, as you're thinking through this, there's a number of things to consider when you want to think about saving for college. The first one, and this is one of the biggest ones

Starting point is 00:04:38 that people talk about. Do you think that your kids are going to go to college? This is one that I hear all the time. and people are very concerned as to whether or not college will exist, or it's going to be the thing that kids will be doing when their kids go to college, or if they even want to go to college. Maybe they want to start a company or they want to do something else. And some of you right now may be listening to this and saying,

Starting point is 00:04:57 if they want to live under my roof, they need to go to college. And others of you may be thinking, well, college isn't for everyone. To each is on. I don't care which side you stand on. But the reality is 66.2% of high school graduates right now go to college. And will college be outdated in 18 years? I have no idea. and nobody knows the answer to that.

Starting point is 00:05:15 But right now, as it stands, if you want a general career in the world, you have to go to college. Now, you don't have to go to college if you want to go to trade schools or you want to start a company. There's other things that you want to do. But if you want to work at a large company,

Starting point is 00:05:28 you have to go to college. Now, you can agree or disagree with the premise behind that, but in a lot of situations, you have to have a college degree to get specific types of jobs. This is one of the biggest worries for people, though, is what if my kid doesn't go to college?

Starting point is 00:05:42 And I get it. I get why you're asking that question. So if you don't think that your kids may go to college, your boy's going to give you some flexible options today that we're going to talk through. The second consideration is how pricey is the tuition going to be? Because tuition has accelerated faster and faster in the last 20 years. So to combat this, we have to maximize every single dollar that we save.

Starting point is 00:06:04 In addition, it doesn't help that inflation is rising extremely fast and eating away at our dollars every single month. So to combat this, we have to be able to. have to invest those dollars when we're saving up for college. The good thing is, investing your money leaves to bags or racks or big bank rolls, as the kids say. But when you're also thinking about how pricey the tuition could be, the other thing to consider is if your kids have a 4.0 GPA and they're showing shines of a bright future and they're

Starting point is 00:06:30 president of all the things, and you may have a hefty price tag coming up going to an Ivy League school if you don't get scholarships or something like that. Or maybe they want to stay home and pursue their rap career. So you're going to have less of a bill if they're going to community college locally. These are going to be two very different situations. So we're going to talk about three main ways to save for college today. You don't have to choose just one of these ways to save for college. The thing to understand is that you can have a hybrid method of some of these.

Starting point is 00:06:57 Some of these have more restrictions on when you can take the money out, where some have more flexibility as if your kid doesn't go to college, you can utilize this money to just invest like it normally would be. So there's a number of different things to consider. as you're thinking through this, but the thing to understand is you don't have to just go with one method. You can have a hybrid approach with some of these methods, as long as you fall into the guidelines

Starting point is 00:07:19 and there's no restrictions around your specific situation, which we'll talk about that in a second. So if that's something you're into, we're going to jump into the three different ways to save for college. So let's dive into the three college plans that I would consider. And before we dive in, just think through the pros and cons of each one. Like we just talked about,

Starting point is 00:07:38 You can have a hybrid approach to each of these. Because if you're worried about your kid not going to college, what you can do with this hybrid approach is say maybe put half of your money into one that's more flexible and half of your money into one that's more tax advantage for someone who is going to go to college. So there's a bunch of different things to look at here, but you could put 50-50, you could do 25-75, whatever you think is best for your situation. And then look at how flexible these plans are as well. So let's dive in.

Starting point is 00:08:03 The first one is called an education savings account or an ESA or some people, also call these education IRAs. Now you know, your boy loves himself a good old-fashioned IRA and an ESA works a lot like a Roth IRA. So the way that it works is that you have to utilize it for education expenses, but it allows you to invest up to $2,000 a year after tax per year per child. And then it grows tax free. So it's money that you've already been taxed on. You put inside this education IRA and then the money grows tax-free over the course of 18 years or however long that you started saving up for college. So you can put $2,000 per year per child. So if you have three kids, you can put $6,000 per year. Each one has their own ESA. Now let's do some math here because

Starting point is 00:08:53 if you put away $2,000 per year starting when your child is born, by the time they turn 18, you would have invested $36,000. Now if you just stuffed $36,000 away into a savings account, that's not going to be enough to cover college in 18 years for most situations, maybe at a community college or something like that. But to cover four-year tuition in 18 years, it's going to most likely be much higher. But if you put it in an ESA, you don't have to pay taxes on the growth of that money. And you get a 10% rate of return in something like an index fund or an ETF and an S&P 500 index fund is how we run these numbers. Then that $36,000 over the course of those 18 years is going to grow to about $95,000.

Starting point is 00:09:37 So monthly, what that means is you're investing $167 a month into this ESA, and it's going to grow to $95,000 in 18 years. Congratulations, you just paid for a four-year college for your kids. Now, if you think college is going to be way more than that at that time, then maybe you need to put a little more, and we'll talk about how much to put in later. But doing this, putting your dollars into this ESA account or this education IRA means that you can invest those dollars and get the tax benefits that you need. You won't have to pay taxes on any of the gains when you withdraw the money or put it

Starting point is 00:10:09 towards education expenses. Now, what does that mean? Education expenses. There's actually a number of flexible options within ESA and the next option that we're going to talk about as well where you can use this for a number of different things. Like with an ESA, you can use it for K through 12 private school tuition. You can use it for vocational schools. You can use it for textbooks, school supplies, or even tutoring.

Starting point is 00:10:29 So there's a lot of things that you can use this money for. And here's one thing I love. Say, for example, you have multiple kids, and one of your kids does not go to college. They decide they don't want to go to college is not for them. You can transfer the money to another sibling. So that is a really cool perk. It gives you a little bit of flexibility. And usually with an ESA, it gives you the least friction to transfer money over to another sibling.

Starting point is 00:10:52 So this is one of the most flexible options in this situation. Now, one thing to consider here, with an ESA, there are income limits. Just like a Roth IRA, there's income limits. So if you're married and your adjusted gross income is over $220,000, then you can't contribute to the ESA, which I'll give you an option next where you can contribute to something else. Or if you're single and you make $110,000 a year more, you can't contribute. Now, that's at the year I'm recording this. These numbers may go up in future years.

Starting point is 00:11:21 So I'll leave a link down below so you could check out what the current year is. The other downside is that you have to utilize the money before you're 30. So some of these other options, you can have more flexibility and utilize it whenever you want. But with an ESA, you have to utilize it before you're 30. Otherwise, you're going to have to pay taxes, fees, and penalties when you withdraw the money for education expenses, even if it's for education expenses. So you have to use that money before the age of 30. So here's why I like it is there's a bunch of investment options. You can invest those dollars.

Starting point is 00:11:50 The money grows tax-free and you can have a higher rate of return because you can invest those dollars and you don't have to pay those taxes. But there's also cons to this, which is, A, the limit to only be allowed to invest $2,000. So if you have someone who may be a doctor or a lawyer and have really high education expenses, or they go to an Ivy League school, then only investing $2,000 may not be enough, but you can utilize some of these other hybrid approaches. And you also must be within those income limits to be able to contribute. That's another downside. And that they have to be utilized by the age of 30.

Starting point is 00:12:22 So those are the three downsides with this one. But it is a very flexible option. So if you fall into those income limits and you think your child is going to go to college, this is a great option for you as the first option because that money growing tax-free, obviously, is the majority. So look into this option as your first option if you qualify. I remember when I needed to hire someone fast, but finding the right person quickly felt impossible. And if you've ever been there, you know how stressful this can be.

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Starting point is 00:16:20 for you. But there's one thing I want to talk about up front is you got to be very careful because Some 529 plans are absolutely terrible out there. They have high fees and they don't allow you to utilize your money the way you need to be utilizing it. So what you need to be looking at here is you need to be looking for flexible 529 plans. That's what they're called. Flexible plans. So most standard brokerages have this option. If you're going to open up a 529 plan, you can look at Vanguard or Fidelity.

Starting point is 00:16:45 They both have those options to open a flexible 529 plan. Because the ones that are not flexible, like I said, have high fees, but they also can freeze your investments based on the age of the child. And there's a bunch of different stupid rules that come into play with when they're not flexible 529 plans. So make sure you have the flexible plans. I cannot stress that enough. But the cool thing is, just like an ESA,

Starting point is 00:17:08 a 529 plan can be used for things like education expenses, K through 12 tuition, vocational school, textbooks. But you can also use it for things like taking cooking classes or you can pay for language classes or trained for new career accreditations. And you can even use them to study abroad, which is extremely cool. So I've seen situations where a couple's kids

Starting point is 00:17:29 decided not to go to college, and that couple ended up retiring right around the time their kids went to college. So guess what they did? They both studied abroad and took classes abroad and got to travel the world with that money tax-free. That was the way they decided to utilize that money instead of taking a penalty.

Starting point is 00:17:44 So then another reason you want to choose the flexible plan is just because it allows you to transfer money, from family member to family member, much easier than these other plans that don't. If it's not a flexible plan, sometimes you can't transfer the money to siblings or if you wanted to do that study abroad plan, you can't transfer it back to yourself or your spouse or whoever else.

Starting point is 00:18:03 And 529 plans tax-wise work exactly the same way. So you have the tax-deferred growth, meaning your contributions are going to grow tax-free if you utilize that money for education expenses. And then no income tax is obviously paid on the growth of your money as well. Now, if you don't use the money for educational expenses, say your kid doesn't go to college and you want to just take that money out, you incur a 10% penalty plus you pay taxes on the gains. That's what happens there, but you're not taxed on the money. That's your original contribution. So if you contribute money, you're not taxed on that money, but you are taxed on the gains.

Starting point is 00:18:39 So this is where I'm really less concerned if my kids don't go to college because that 10% penalty is truly the only issue. So let's take the example that we had in the last one. So say, for example, you contributed $2,000 per year into an HSA. So in 18 years, like we talked about, that would grow to $95,000. But $36,000 of that is what you contributed, because $2,000 a year for 18 years is $36,000. So what that leaves you left with is if you subtract $95,000 from the $36,000 you contributed is $59,000 there is left to penalty and tax.

Starting point is 00:19:16 So if you take a 10% penalty, that's $5,900 on that $59,000. And if you take a 15% tax, then that's $88. Say you got a capital gains tax or something like that around 15%. And that's $8,850. So what would happen here is you would lose $14,750. Yes, that's a lot of money. I understand that. But here's the thing.

Starting point is 00:19:40 $44,250 would be left over after all those taxes and a 10% penalty hit. So that would be an additional $44,000 you did not have if you just stuffed that money into a savings account. This is the problem with a savings account. But you would have an additional $44,000 after all the taxes and fees versus having much less in a savings account. So this is why, thinking through the fees a little bit, you still will come out ahead if you're investing those dollars. Then if you're just stuffing it into a savings account, worried about your kids not going to college. Now, like I said earlier, we may have an entire episode on 529 plans because there's so many different things that you're can do with them. There's a lot of loopholes you can utilize in terms of estate planning as well.

Starting point is 00:20:21 So the reasons why I love the 529 plan, the reason why I'm utilizing it is you can have higher contributions rate. So you can contribute up to $300,000, but each state is a little bit different. So check your specific state. And I'll leave a link in the show notes so you can check those out. And then most of the time, there aren't any income limits or restrictions based on age. Because if you get that flexible plan, typically there's no restrictions on income limits or age. and the money grows tax free. And really the only downside that I see to a 529 plan is A, the penalty obviously.

Starting point is 00:20:53 But B, is that restrictions may apply if you choose to transfer your 529 plan, especially if you don't have one of those flexible plans. So if your kid doesn't go to college, you got that 10% penalty that you may have to pay. But in addition, it may be harder to transfer if you don't have a flexible plan. So again, look at flexible plans.

Starting point is 00:21:10 The third option we're going to talk about today is a UTMA or a UTMA, UGMA account. So this is one that we're going to talk about in the future and have its own episode as well, because this is a great way to teach your kids about investing and to actually put those investing dollars in your kids' name when you want to start investing money for your kids.

Starting point is 00:21:29 So if you've already done an ESA or a 529 or you don't qualify for an ESA, then this is the most flexible option, but it doesn't have any of the tax benefits that the others do. So there's no tax benefits to investing your dollars here, but it does give you flexibility if you want to utilize and put that money into your kid's name and invests to those dollars. So the way that it works is that the account is actually in your child's name,

Starting point is 00:21:52 but is controlled by the parent or the guardian until your child reaches 21. And then once they turn 21, they'll be able to control the account and do whatever they want with the money. So what you're essentially doing is you're opening up a mutual fund in your kid's name. So if they want to blow all their money on a trip to Abiza with Mike Posner and all their friends, then they can do that. But if you listen to the personal finance podcast, Your boy is going to teach you how to teach your kids about money.

Starting point is 00:22:16 And we're going to teach them how to have a better financial future. So talking through some of this stuff is extremely important so that doesn't happen. So this is the reason why it's my third option, because you don't have the tax benefits that are there. Yes, you have extreme flexibility, but you don't have those tax benefits in terms of not having to pay taxes on the gains on your money. So what does that save? That saves 15 to 30% depending on what your capital gains tax is, which can add up to a lot of money. If you have a 30% capital gains rate, every $100,000, that's $30,000 that you could be taxed on that money. So you want to make sure that if you're having a tax advantage is you want to look at something like a 529 plan or an ESA.

Starting point is 00:22:53 Now, reasons why I like it again? Way more flexibility. And if funds can be used for anything, it doesn't have to be used just for college expenses. But the reasons why I don't like it is that they have full control when they turn 21 so they could just blow the money. And the beneficiary can't be changed after selected. So one of the thing to note here is that you can't select a beneficiary to it. Say you select one of your kids, you can't change that beneficiary later on. They own that account once you select them.

Starting point is 00:23:19 So we'll have a full episode because I like to utilize the UTMA or the UGMA in a different way to teach your kids about investing so you can still give them those dollars when they turn 21. But for me specifically, it's my third option when saving for college. Now the next two things I want to talk about is first I want to talk about how much each savings rate would be for 18 years at a 10% return. So we're going to go through a bunch of different savings rates here. So you can figure out, hey, how much money do I have to save every single month so that I can hit my goals when I want to save up for college?

Starting point is 00:23:54 So one thing to note here before I dive in is we are building out an investment calculator for you guys. That's going to be completely free. So what you're going to be able to do in the future here, and if you're listening to this couple months in the future, you're going to be able to utilize this investment and calculator do these calculations on your own as well. I'm going to build this out because I want you guys to be able to do these calculations all the time. I run calculations like this every single day. Why? Because to me, this is extremely motivating. It's motivating to see how your dollars can start to work for you and how much they can grow in such a short period of time. So over the course of 18 years, you're going to see, hey, I'm going to contribute X amount of dollars and it can grow to this much and I can completely pay for my kids college once I take care of my own retirement. But these numbers also work for your retirement. as well. So make sure you check out our investment calculator. If you're listening to this way in the future, then it may already be built. I will leave a link to it in the show notes as well so you

Starting point is 00:24:46 could check that out if it's already built. So let's say, for example, you say $50 a month for 18 years for your kids college. Well, if you got a 10% rate of return and how do you get a 10% rate of return, you look at something like an S&P 500 index fund. And since 1929, it's got a 10 and a half rate of return at the time I'm recording this. Now that may adjust to 8, 9, 10, somewhere in that range between 8 to 10% is where you can conservatively look at this. So $50 a month would be $28,591. Okay, well, what if you bumped it to $100 a month? That'd be $57,183. So for $100 a month, you can have $50 grand saved up for your kids' college, almost $60 grand. Now what if you bumped in another $50? $150 jumps up to $85,775.

Starting point is 00:25:37 We've talked about a number of times already on this episode. It would be $95,000. What if he bumped it up to $200? That'd be $114,000. Maybe to $300. That'd be $171,000. $400 a month would be $228,000. $500 a month would be $285,000.

Starting point is 00:25:58 So this is the area where we're getting to, where if you have multiple kids or something like that, maybe you want to invest, say, $3, $500 so that you can cover the majority of their expenses. $600 is $343,000. $700 a month is $400,000. $800 a month is $457,000. $900 a month is $514,000,

Starting point is 00:26:21 and $1,000 a month is $571,000 over the course of 18 years with a 10% rate of return. Now, one thing to note here is do not put too much money into these accounts, especially in the 529, the education account or the ESA, because you don't want to have too much money in there, and then your kids go to college and they only spend 100 grand, and you have 300 grand in there, and now you've got to look at penalties and figure out how to get that money out of there.

Starting point is 00:26:47 That's the last thing you want to do. Now, in a 529 account, there's a number of different things that you can do on a strategic side, which we're going to talk about in that episode, but you just don't want to put too much money into your 529 if you can't get it out. Now before we wrap this episode up, the last thing I want to talk about is what if you started saving up late for college? Now, if you started saving up late for college, maybe you have a teenager, 13, 14, 15 years old, and you're trying to figure out what do I do so that I can play catch up now that I'm finally funding my retirement, I've got my finances in order, now I'm starting to want to catch up so I can start to reduce that burden for my children so they don't have student loans and things like that in their adult life. then there's a couple of things that you can do. The first one is to apply for scholarships.

Starting point is 00:27:32 Now, this is something that I really wish I did more of in high school. I really wish that I tried to apply for more scholarships in high school because there's a million different scholarships out there. Now, a lot of people don't want to apply for specific scholarships because, A, it gets them like $500. But listen, if you do that a bunch of different times and you win a bunch of these scholarships, $500 is going to add up over time.

Starting point is 00:27:52 So getting as many scholarships as you possibly can is really financially in your child's favor because what you can show them is, hey, if you got a student loan here, here's the interest rate of a student loan, and here's how much you're going to have to pay every single month with these student loans. So reducing this dollar about as much as possible is going to be incredibly beneficial for you specifically when you get to your adult life. You don't want to start your adult life in the negative, which most people do, so applying for these scholarships can be extremely motivating, especially if you're teaching them the power of each dollar when they're young and they can say, hey, I'm 21 years old and every single dollar

Starting point is 00:28:29 that I spend is worth well over $80. So understanding that a front may help motivate to apply for more scholarships because I know it stinks filling out those applications and writing essays and stuff for them, that stuff is difficult. But doing it up front is going to be incredibly beneficial for them. The second one is to apply for aid. So there's a bunch of federal student aid out there. There's things like the FAFSA program, FAAFSA. And so if you fall into certain income limits, you can qualify for aid. So I'm going to leave a link down below on the government website where you can check this out to see if you qualify and you can apply for this as well on that website.

Starting point is 00:29:03 It's called studentaid.gov and I'll link it up in the show notes below so you can check that out as well. In addition, the third thing to think through is see if your child can qualify for AP classes or advanced placement classes. So what this is is it gives high school students a chance to actually take college classes, community college classes, while they're in high school. And every single AP class that they take in high school means it's one less college class that you have to pay for once they get to college. So this is a tremendous benefit that's offered that's offered and if it's offered, make sure you take advantage of it.

Starting point is 00:29:37 A, it helps prepare them for what college is like and what the college coursework and workload is. But in addition, B, it saves you a tremendous amount of money. So take as many AP classes as you can. I've seen people as early as their junior years start taking AP classes. So look into doing this so that you can reduce that load. So apply for scholarships, apply for government aid, and take AP classes, or the three things to look into if you started to save for college late.

Starting point is 00:30:05 Now, listen, I hope you guys learned a bunch of stuff on how to save for college the smart way. If you have any questions, hit me up on TikTok or Instagram at Master Money Co. And follow us on Spotify, Apple Podcast, or whatever podcast player you love listening to this podcast to. And if you want to help out the show, leave a five-star rating and review on Apple Podcasts or Spotify.

Starting point is 00:30:26 I truly appreciate each and every one of you who have been leaving five-star reviews. It makes my day every time I see you guys leave those five-star reviews in the comments that you're leaving. They're absolutely amazing. Thank you so much for leaving those reviews. And then lastly, if you want to check us out on YouTube, we are Master Money on YouTube where we're coming out with two videos every single week with different content from the podcast. so you can check that out as well. Thank you guys so much for listening to this episode.

Starting point is 00:30:54 I truly appreciate each and every one of you, and let's build generational wealth together. We'll see you on the next episode. Frozen lasagna, medium power, 15 minutes. Sounds like Ojo time. Let's play. Feel the fun with Play Ojo, the online casino with all the latest slot and live casino games.

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The Personal Finance Podcast - How to Save for College (The Smart Way!)

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