By this time, you should have completed Baby Steps 1 through 4 in Dave Ramsey’s Baby Steps:
- Save $1000 for emergencies
- Pay off non-mortgage debt using the Debt Snowball
- Save 3-6 months of expenses for emergencies
- Invest 15% of your household income into Roth IRA’s and pre-tax retirement funds
The first three Baby Steps are each meant to be completed before moving on to the next step. Baby Steps 4, 5, and 6 can be done simultaneously. Step 5 in Dave Ramsey’s Baby Steps is to save for your children’s college education. What’s important is that you don’t start saving for college before you have begun saving at least 15% for your own retirement. Make sure you are taking care of your retirement before your kids’ college!
How much do I save?
First, have a meeting with your spouse to decide what your goal is for college funding. Do you want to pay for 100% of your kids’ college expenses? Or, would you rather help out with a portion of the cost? Are you hoping your child goes to a private college or an in-state university?
Once you agree on a goal, do some research to estimate the total cost of college in the future. This tool from The College Board helps you assess the cost for two or four years of in-state, out-of-state, and private college costs.
Where do I save?
A 529 Plan is the most popular way to save for future education expenses. The benefits of a 529 Plan include the ability to save in mutual funds, high contribution limits, and tax-free withdrawals if used for education. If one of your children doesn’t go to college, you can change the beneficiary on his account to another family member. These types of accounts are administered by individual states, and many states offer a tax deduction for saving in a 529 Plan. Some states, like Arizona, still allow a tax deduction no matter which state’s 529 Plan you choose.
Another way to save for college is in a taxable investment account. Unlike a 529 Plan, money saved in a taxable account can be used for other purposes, like paying for a wedding or supplementing your own retirement. This flexibility is more appealing to some parents than the tax-free distributions of a 529 Plan. Withdrawals from these accounts are taxed as capital gains, which are taxed more favorable than income.
With the growing burden of student loans, saving for future education expenses can be a huge blessing for your children. With so many unknowns, it can be hard to know how much to save, where to save, and how Baby Step 5 fits in with your other savings goals. Schedule a time to talk with our financial planners to get a personalized plan for your money!
Jake is a co-founder and Director of Investing at Stewardship Financial. In his role he gets to help people make smarter decisions on how to invest in the capital markets.