It was late 2017. I held my 1-day old son in my arm. As a father, I felt tremendous amount of responsibility towards this child. I started to think about his future, how fun would it be to watch him grow, how he would be my ski buddy, how we would drop him off to his first day of kindergarten, elementary, first year of college… wait a minute, college! That would cost an arm and a leg when he grows up, I thought to myself.
Out of emotion, I immediately thought about opening a college fund for him. I knew that college tuition rose faster than inflation, often faster than the pay raise rate. Student loan had become massive. I certainly didn’t want our son to pay student loan for decades.
When we got home, I started to research around how to pay for college. I remember I had to borrow money from family in order to finish college while working several jobs to support myself. It didn’t took decades to pay it off, but it was still painful.
I knew about ESA and 529 before, but I started to dig more on their pros and cons. To summarize:
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ESA (Educational Saving Plan)
- There is an income limit in order for you to qualify (at the time of this writing, the limit is $110,000 or $220,000 if filing joint return)
- $2,000 limit for annual contribution
- The beneficiary must be below age of 30
- There’s no income limit to contribute
- The annual contribution is capped at $14,000 (gift tax consequences otherwise)
- No age limit on beneficiary
The money coming in is post-tax. It grows tax free. Contribution is tax and penalty free as long as it’s use for qualified, education-related expenses. You want to open it under your name and name your children as the beneficiary. Open separate account for each child. Beware that this might affect your children’s eligibility to receive a financial aid since the money invested in college saving counts towards Expected Family Contribution (EFC). We find it kind of ironic that the parents who prepare for their children’s education can get “penalized” (get less money from a grant, for example).
Retire By’s take on ESA / 529
While these investment vehicles do the jobs they suppose to do, they are somewhat inflexible on the withdrawal part. Comparing to HSA, I’m sure everybody will need some kind of medical coverage on retirement, thus it’s always worth funding. As for ESA / 529, there’s uncertainty if we will optimize the fund that had been building over a long period of time (e.g. 18 years from the day your child is born). What if he doesn’t want to go to college? What if he gets full scholarship? Should we invest that money towards our early retirement accounts instead?
I consulted with our CPA on 529, see what his take is. He recommended to look into the option of utilizing our Roth IRA accounts instead of 529 to fund our child’s education. Hmm this is interesting thoughts. The money in Roth IRA can be used for general-purpose expenses, not tied to education-related purposes. This is certainly liberating.
The idea is, the contribution (principal) that you put into Roth IRA can be withdrawn after 5 years, penalty and tax free (since you’ve already paid tax on it). And in the process, the equity gain inside the account can exceed the principal amount over a longer period of time (e.g. 18 years).
However, you can only contribute $5,500 annually to your Roth IRA ($11,000 total if your spouse contribute to Roth IRA as well). Over 18 years, you will have access to $99,000 fund on each Roth IRA.
If you plan to retire early, chances are, you won’t contribute to Roth IRA for 18 years. Let’s say you contribute for 10 years, that amounts to $55,000. Depending on how many children you have, this might not cover all education expenses.
So what if you really want to fully fund your kid’s education in the future? There are a couple more techniques to contribute more to your Roth IRA. You can read more about Mega backdoor Roth IRA and the Roth IRA Conversion Ladder.
While you want to be responsible parent, you need to balance contributing to your children’s education and funding your retirement.
Your children have many more years before retirement comparing to you. They will have more time to figure things out. I personally think it is more important to teach financial principles and impart fighting spirits to your kids, rather than having a fully funded 529 account.
Perhaps it is ok for them to work part time jobs or do some side hustling while they are in school. It is ok to let them work hard to get a scholarship or grant. Many universities provide college stipend if you become a Teaching Assistant on your Senior year.
Or, perhaps by the time they reach college years, they already have a profitable side gig, say photography, blogging? 🙂
Having say all of that, I completely understand the emotion aspect on this. Despite any sort of calculation, Mr. and Mrs. RetireBy still put a small seed money into our son’s Vanguard 529 account as a birthday gift for some sentimental value and to encourage him to seek for higher level education in the long future.
I don’t know what the future of education looks like for the next generation. As a parent, I do want to provide the best and prepare them for the future. But this doesn’t mean we can’t optimize how we will get there.
Thoughts? What’s your take on college fund?