Sunday, May 25, 2008
Saving for College
By some estimates, in state tuition plus expenses at state colleges will cost between $30-40k per year by the year 2025. At private colleges, these estimates are as high as $100k+ per year. With this in mind, we're planning to start a 529 college savings plan for the little guy. If anyone out there has any suggestions based on your own experiences, let us know. We'll post some of your ideas at a later date.
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My understanding is that you can take money from your Roth IRAs without penalty if it is used for educational purposes. That would include a child's college expenses.
So, if you don't have Roth IRAs maxed out per year, then it may be worth looking into this approach prior to the education IRA.
Why...
- If the child doesn't go to college, you have added to your retirement portfolio.
- All the various benefits of a Roth: Access to contributions without penalty (if necessary). Tax free withdrawals when reach the "retirement" age. There are probably others.
- I believe retirement accounts are not part of the financial aid assessment. Therefore, you would be "hiding" some available funds.
You will have to look into this much more deeply if this is of any interest because the above info is just off of recollection.
Michael and Alison - hey! I just took a financial planning class at Wharton and have been doing reserach into my own 529 plans, so I'll let you know what I've learned. This could be a long post.
First of all, a 529 plan is indeed the way to go, tax free earnings and tax free withdrawls, just like a Roth IRA (as long as the proceeds are used for a qualified educational expense). You can also invest in any 529 plan, not just the state you live in, as you probably also know. Since Texas does not provide any tax deductions or credits for a 529 plan (no state income tax - awesome!), you have the opportunity to look around the country for the best 529 plan.
Through my research, I believe the best is Utah's plan. Here's why - investment through Vanguard's family of funds and rock bottom fees.
Vanguard's funds are great because it's a mutual company (unlike say, Fidelity or Janus) that's owned by its members. They also contract with some of the best investment companies such as Schroeder or Wellington, and have a solid quantitative and bond group. (They basically avoided investing in the subprime mortgage bonds). Vanguard also has a reputation for very low expenses, usually 100 basis points lower than their average competitor annually.
Money magazine listed 5 states as the best for out of state investors. They were Iowa, Utah, Nevada, Michigan, and California. I narrowed that to Iowa, Utah, and Nevada because they used Vanguard. Iowa and Nevada plans are administered by Upromise (more on this later) and thus have total expense ratios of around 50 basis points (.5%) annually. Low, compared to other plans, such as Texas' current 529 plans, which I believe are sold through a broker. Upon examining Utah's fees, there is a $20 maintenance fee annually and fees that range from 25 to 39 basis points. .15% difference doesn't sound like a lot of money. However, I made a model in excel, assuming you save $400 per month and grow at the historical rates of the plan ($400 a month is the projected amount you would need to pay for UT). Over the life of the investment, this difference in fees adds up to around $4,000. Not chump change in my book. Imagine what the difference would be if you invested in a 529 plan that had fees in the 100 basis point range.
The attractive thing to me about Nevada and Iowa was that they link with Upromise. Upromise is a company that partners with retailers and restaurants that offer rebates for college savings on your purchases. All you have to do is link your credit card (or the cc's of parents and friends) and when you make a purchase with your card (such as at Mobil gas stations) 1%, for example, is deposited into your upromise account. What upromise would like you to do is sign up for one of the 529 plans they administer, such as in Nevada, and then they will transfer your balance directly into your 529 account there every quarter. However, after considerable digging I found out that it is possible for you to send them a notorized letter and have them send you a check, which you can then depoit into the 529 of your choice. I didn't think this inconvenience was worth the higher fees of their 529 plan such as Nevada and Iowa, which both charge around 50 basis points.
Another option is the education IRA, but I believe the 529 is superior. First, the education IRA has a annual contribution limit of $2000/yr. As I stated above, this will not cover projected tuition at a public university. 529 plans have no such annual limits. Also, there is an income phaseout above which you can no longer invest in an education IRA. The only advantage to an education IRA is that you can use it for tuition before college, such as private elementary or high schools. If you anticipate those expenses, then I would recommend a two tier strategy.
Finally, I would never raid your Roth IRA for education. Your first responsibility is for your retirement, and Roth IRA is the best deal out there (next to doing the minimum to achieve your company's match). Besides the great advantage of tax free buildup and withdrawl, there is no required minimum distribution from Roth IRAs, making them great wealth building vehicles. At the end of the day, the kid can pay back college loans. No one will give you a loan for groceries during your retirement.
Sorry this was so long. I'm sure there are others that know a lot more about this than me, and I'm eager to here any opinions or comments.
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