pay for college

Save for both college and retirement.

New parents who want to send a child to college, and also retire one day?

This method will put away $94,000 for college, and is likely to add a bonus $50,000 or more for retirement.

The 2 keys to save for both college and retirement are:

  • an early start.
  • the Roth IRA.

This method works great for the 82% of American’s who aren’t using IRA’s.  If you are already taking advantage of an IRA for retirement, this may not be the method for you.  If you aren’t utilizing Roth IRA’s this method will help you save for both college and retirement at the same time.

But wait:  Aren’t Roth IRA’s for retirement, and 529’s for college?

529 plans are the obvious, highly-marketed college saving vehicle, but they have 3 disadvantages. 

Disadvantage 1.

What if something happens, and your kid doesn’t use the money for college? 

Your kid might:

  • Join the circus?
  • Get a higher paying job as a welder?
  • Hate school and not want college?
  • Be the greatest soccer player the US has ever known?

529’s are transferable, and the money could be withdrawn with a penalty, but there is great uncertainty with large amounts of money dedicated to college plans 17 years in the future.

Disadvantage 2.

Even, if the Money in a 529 is used as planned, there are still downsides. Money in a 529 counts as an asset, and negatively affects the FAFSA.  $94,000 in a 529 would increase the EFC (expected family contribution) by over $5,000.  529’s are in the parent name, and even money allocated to other siblings hurts FAFSA results, impacting student aid packages.

Disadvantage 3.

529’s plans vary, but some have limited investment choices.  The plan in Virginia only has about 20 investment choices.

Basics of Roth IRA’s

Roth IRA’s allow a yearly contribution of $5500.  To contribute, you must earn $5500, and that money was already taxed.  At withdrawal, only the profits will be taxed.

For more info on ROTH IRA’s, check out this great 3 part series by Liz, at Chief Mom Officer.

What makes Roth’s effective college savings tools, despite their marketing as retirement accounts?

There are 4 main benefits.

  • No tax on the profits until withdrawal in retirement, meaning a Roth doesn’t influence current income or tax filings.
  • The contributions can be withdrawn once the account is 5 years old, and the tax on that contribution was already paid.
  • Money in a Roth IRA is considered retirement money, and does not affect the asset category of the FAFSA.
  • Money is moved to another account making it inconvenient cash. Savings accounts are too convenient, and more likely to get raided.

Steps to save $94K for college in a Roth.

  • Open a Roth when a baby is born.
  • Contribute $5500 each year.
  • 17 years later the baby graduates high school.
  • $93,500 has been contributed.
  • The ROTH is older than 5 years, and the $93,500 contribution can be used for college.

This may seem difficult, obvious, or just unimpressive.  If you followed these steps you have 94 grand, simply because you saved 94 grand.  Saving $5500 instead of buying things like cute baby cribs or baby clothes, will take discipline.  Contributing $5500 per year might seem tough, but the average cost of attendance of public state schools is over $20,000 per year today.  Nobody knows the future, but cost is likely to be significantly more in 17 years.

It’s just my experience, but I remember most of college, nothing about my crib, and would have been adorable in any baby clothes.

A significant chunk of money is now painfully saved for college, but what about retirement?

We haven’t mentioned the bonus of earnings from the invested money.  Putting $5500 to work when your baby is a baby will do great things, because the money has 17 years to grow and collect interest. 

Check the top row of numbers on the table.  $5500 invested 17 years at 5% is worth $12,600 at graduation.  At 10% interest it has grown to over 27 grand.

On the other hand, a recent $5500 contribution at age 16, is near the bottom of the table, and has only earned $225.  The table shows all the middle years, and different sample profit yields.

The most effective contribution years are when the kid is young.

save for college and retirement

 

The stock market never goes in a straight line, but if the investment earned 7% the entire time, the Roth would have value of over $180,000 at high school graduation.

A less healthy 5% yield still gives a final value of almost $150,000.

Crazy great 10% gains result in over $245,000.

The future is uncertain, and stock markets rise and fall. This post is not about risks and rewards of investing in stocks, but profit from the stock market is essential to this method.  Stocks are not guaranteed, and it is possible you could lose money investing.  Do your research and decide if and how you should invest.  One of the advantages of a Roth is the investment options are almost limitless.

What about this plan if you have 2 kids?

Your spouse can also contribute $5500 per year to their Roth IRA.

Got 3 kids?

Sorry. Good Luck.  You can read this post about one more kid, but it might just sound mean, and doesn’t include a strategy.

Did I follow my own advice and execute this plan?

Nope.  Not even close.  This is a 20-20 hindsight plan I hatched after turning around, realizing that JS Jack was already in college, and JS Jill is driving.

$5500 spread over a year is $458.33 per month, and this method will leave you prepared for college expenses, without affecting FAFSA and financial aid.  All the profits will be available for withdrawal at retirement, and will not be taxed until they are withdrawn.

The JumpStart household has recently become serious about cutting spending, and saving $18,000 per year for our kids’ education.  18 grand saved this year pays for college next year.  We are in the first year of a 7 year journey with a big double-whammy year in the middle.  I waited to begin ROTH contributions until my son was 15, and lost out on a big opportunity.

If you are the lucky one whose daughter joins the circus gets that full ride soccer scholarship, all the money can remain in your retirement fund, where it will have even more time to do great things.

Posted in Family finances, Paying for college..

6 Comments

  1. Great post Mr. JumpStart! You dont need more types of accounts, just the flexing of what you already have :). Quick question for you, do you need to wait 5 years to withdraw Roth contributions? I’m always confused about this. I seem to remember some places say you can always withdraw contributions, but you may be able to withdraw earnings after 5 years if..

    • Good question. I know my plan works. I ‘ve never withdrawn money from my Roth. I bet the answer to your question is in Chief Mom Officer’s series. If memory serves, it is 5 years for withdrawal of contribution, and earnings must wait until retirement age, and disbursements are forced. You can ignore the 5 years, or retirement age rule, but there are nasty tax penalties. There may be some exceptions when using funds for education?

  2. I’m already maxing out a Traditional IRA. I expect to be in a lower tax bracket in retirement than I’m in today so Traditional is more effective than a Roth for me. I’m torn on contributing to a 529 or taxable account for some of the reasons you mention.

    • The 529 policies vary by state, making the programs more difficult to find reliable evaluations.
      529 contributions create state tax deductions up to a certain limit in some states.
      The profits from 529’s are exempt from income taxes.
      I’m not really sold on them. Their biggest drawback to me is their lack of investment choices.

  3. Great post! Too bad you didn’t have the foresight to do this yourself, but great advice for new parents.or parents of young children. I’ve often thought that lack of flexibility was the biggest disadvantage to 529 plans (as you say, who knows what will happen 17 years from now), but I had no idea that this money counts against you with the FAFSA.

  4. Pingback: 17 Year End Tax Moves & 1 More Thing to Save Money - Super Saving Tips

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