Ask the grumpies: How best to save for kids’ college

First Gen American asks:

I would love a post on savings bonds as a vehicle for college savings…pros and cons vs 529. Also is one better for high earners. There seems to be some language about earning limits on the tax deductability of the earnings but no penalty if not used for educational expenses.

Disclaimer:  We are not professional financial planners.  Before making important financial decisions, talk to a fee-only financial planner with fiduciary responsibility and/or do your own research.

According to this page from the treasury:

For single taxpayers, the [education] tax exclusion income limit [for savings bonds] is an adjusted gross income of $92,550 and above. For married taxpayers filing jointly, the tax exclusion income limit is an adjusted gross income of $146,300 and above.

So to me that says that savings bonds are not a good vehicle for college savings for high earners.  Maybe if they’re the kid’s and the kid is not filing as a dependent, but that seems risky too given how FAFSA and CSS heavily weight the kids’ savings (exceptions here).

Savings bonds are also a less risky, lower earning asset.  Given the lack of tax advantages for higher earnings and current interest rates, they’re not much better than CDs or high interest savings accounts for low-risk low-earnings savings and will also show up in financial aid decisions.

So… for both high and low earners in the “may get some financial aid” range, the best thing to do with your money is to put your savings in places that won’t count against your financial aid– so fill up retirement accounts (especially IRA Roths if you can since you can take out the principal on those in case of emergency), pay off credit cards, put money in home equity below what CSS forms pick up, fill up your HSA, and so on.  (Forbes magazine is probably the best place to look for these kinds of limits/suggestions.)  That may seem counter-intuitive that the best way to save for college is to hide money in ways that it is more difficult to tap for college, but financial aid is powerful and you can take out (short-term) loans for college but you can’t take out loans for your retirement (and taking out loans for your mortgage can be expensive and problematic).

AFTER you’ve hidden as much as you can, I still think the 529 in a state that either gives you a state tax break or, failing that, a state that has good Vanguard options with low fees is your best bet.  You could also do a Coverdell if your income is low enough (<220K in 2017 and 2018), but they’re not really any better than 529s unless you have private K-12 tuition that it could go towards, and the limit is pretty small.

If you are too high income to qualify for financial aid (and note that that income may be higher than you think) then you don’t need to play games hiding your income and savings because there’s not anything you could do to get things low enough for colleges to pitch in.  It may also be worthwhile in this case to push some savings onto the child so as to take advantage of the child’s lower income.  If you’re in this situation, don’t just read free advice from the internet– pay for a fantastic fee only financial planner with fiduciary responsibility and get all of your financials in order.

High earners and grandparents cutting down their estates may want to look into frontloading 529s with 5 years worth of 14K gift exclusions or, if they don’t want to force the money to be used for college, they can look into a gift trust.

How are you saving for kids’ college (if applicable)? 

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Ask the grumpies: How to save for multiple kids’ 529s?

First Gen American asks:

Once our mortgage is done again, we’ll swap that out with a 529 auto deposit option that comes out of both paychecks….which brings me to another question…Should we funnel a ton now into older kid and worry about younger kid later (he’s 4 years younger) or should we fund both at the same time now? I’m assuming we can roll over older kid’s excess into younger kid if we over deposit but then if we die before kids do, an uneven distribution would screw things up for kid 2. Not sure what to do yet.

I have also spent some time thinking about this.  I am not sure it actually matters that much.

Yes, if you have too much money for kid #1, you can easily transfer the leftover amount to the second child.  (An added wrinkle–if you undersave for DC1, will you take from DC2’s account?  You can, but would you be willing to?)

A quick check on the internet suggests that the 529 does not automatically go to the child who is named on its behalf– you can name a beneficiary.  It is also something that you can talk about with an attorney for a trust if you do not have a successor that you trust not to just liquidate it at a loss.

We have target-date accounts for our children in their 529s, so it makes sense in terms of risk to fund them separately.  That means DC1’s account has less risk in it right now (a larger bond to stock ratio) than DC2’s does because DC1 is closer to college.  But I’m thinking of them as separate buckets and we’re aiming to fully fund 4 years at a private school given that we’re not expecting much financial aid.

If you’re not thinking of them as separate buckets, then you might want to think of it as if you are going to “retire” and you know you’re going to be alive for 8 years after “retirement” and then suddenly “die” (if you’re planning on funding post-college education, or your DCs might take more than 4 years to graduate, then you might want to add some years to that).  What kind of investment portfolio would be optimal in that scenario?  It’s going to depend on your risk aversion, but you probably could pick a single fund that would fit your risk preferences given that scenario.

In terms of how we’re funding, I don’t actually think that our method of putting in $X/month to each child’s fund is necessarily optimal.  It would make better sense while we have excess cash to put in lump sums right now and stop contributing later (allowing for more tax preferred earnings).  But $X/month/kid is predictable and is easy to fiddle with should our situation change.

The important thing that gets brought up in the comments when we talk about this kind of situation is the perceived fairness of the situation by the kids.  Pick some rule that seems fair for both kids and stick to it.  If you have to make adjustments, make sure that you adjust for the other kid as well.  For us, we’ve decided that fully funding tuition without loans is what we consider fair, so we will be ignoring the actual costs and financial aid for the schools.  Our kids will get college paid for by us no matter what college they choose.  Other people choose a specific dollar amount (though I hope they adjust it for inflation!), or may have a rule like, “we will pay up to the cost of state school X”.  What you don’t want to do is pay full freight for one kid and force the other to take out loans for the full amount because that can lead to them writing about how you don’t love them on money forums, and nobody wants that.

Grumpeteers– How do you think First Gen should save for two kids’ college?