I recently shared stories about grandchildren with one of the partners in our investment club. Her 6 years old grandson and 4 years old granddaughter visit her every Saturday morning. Soon after arrival, the 4 year-old runs to the penny jar and puts a few coins in the piggy bank, counting their value during the process. It’s a play activity without feelings of ownership by the child. The 6 year-old performs chores for which he receives a salary of $2. He originally wanted $5, but agreed to $2 after negotiations with grandmother. In the near-future she will take them to the Dollar Store and let both of them spend a $1 anything they want. They will make the purchase and live with their decision. She wants them to learn shopping skills and the value of money. Later on, their father will open a savings account for them at the local bank. It’s the making of a family tradition.
For the purposes of this discussion, “college” refers to any postsecondary school [ vocational school, 2- & 4-year college, university, professional school ] that offers student aid administered by the U.S. Department of Education.
SUMMARY: The cost of a 4-year college is over $20,000 a year and continues to increase at nearly 4% annually. Paying, not borrowing, is the better way to finance a college degree. Parents can start a payment plan early by investing in a tax-free “529” college savings account. Adults should avoid using their retirement savings to pay a child’s college expenses.
The more effort a family puts into creating a college budget, the better their student’s chance for educational and financial success. There are six important issues to address in the budgeting process:
- Savings plan
- Scholarships and grants
- Family income
- Student loan as the last resort
1. Reduce the cost
High school programs which are designed to reduce the cost of college can prepare students for academic achievement and save them thousands of dollars in college expenses. Families are encouraged to consult teachers, counselors, principals, and colleges about available programs. Here are several types of programs:
- Advanced placement (AP) courses and exams are sponsored by the College Board and participating high schools (ref 1).
- Early college high schools (ECHS) enable students to earn a high school diploma and a two-year associate’s degree or 2 years credit toward a bachelor’s degree. Recruitment starts in middle school (ref 2).
- Community college classes are open to high school students without a diploma. Completion of the classes demonstrates a student’s readiness for college and the earned credit might be eligible for transfer to other colleges (ref 3).
- College-level examination program (CLEP), also sponsored by the College Board, is designed to award college credit for knowledge already acquired. There are 33 CLEP exams that award 3-12 credit hours toward a college degree (ref 1).
Students who wish to get a bachelor’s degree can save money by transferring credits from a community college to a four-year school. Money is saved by paying less at the community college and taking fewer courses to graduate from the four-year school. Firstly, it’s important to earn an associate’s degree before entering the receiver school. Secondly, there’s a risk of losing credits during the transfer unless the participating colleges have an “articulation agreement” on which courses will be credited. Thirdly, the participating colleges may have a transfer agreement that guarantees admission to the receiver school. Try searching for information about “transfer students” in the school websites (ref 4).
Carefully selected online degree programs may provide another opportunity to reduce college expenses (ref 4). Other cost-reduction strategies include adequate, —not luxurious—, room & board, frugal spending habits during college, and graduation on time (ref 5,6).
2. Choose an affordable college
Financial safety schools are those which are most affordable and likely to accept your academic credentials (ref 7). Here are some tips for choosing a college that satisfies your needs:
- Have a study goal and search for colleges that satisfy that goal.
- Search for colleges which are recommended by teachers, guidance counselors, and college-rating websites.
- Use college-ratings to help find affordable colleges [hint: try finding schools with the lowest net prices such as those listed in ref 8; net price is what you might have to pay after receiving financial aid].
- Attend a college fair [hint: ask your guidance counselor for information].
- Visit the websites of colleges that interest you.
- Contact admissions offices and request guided tours of your chosen colleges.
- Review your acceptance letters and visit the admissions office to negotiate the best financial agreement.
3. College savings
It’s cheaper to save than to borrow for college. I would like to join others (ref 9,10,11,12) in advising parents to own a tax-free 529 Savings Plan (“Qualified Tuition Program”; “QTP”) for the benefit of their young child. Owners of 529 savings plans receive favorable tax treatment on the investment returns. The best time to start is before birth or in the first year of the child’s life. It’s important to make regular deposits into the account, preferably by a payroll deduction plan. Here are some strategic details:
- By today’s rules, withdrawals from a parent-owned 529 Plan will have the least impact on the child’s eligibilty for financial aid in college (ref 13).
- The designated beneficiary of the Plan is either the child or a member of the child’s family. The designated beneficiary can be changed without transferring Plans, which allows an adult to start a 529 Plan before the birth of the child by designating a family member as the beneficiary (ref 12).
- The accumulated savings can be transferred from one 529 Plan to another by way of a roll over. The new Plan must be for the benefit of the same designated beneficiary (ref 12). There are several potential advantages, including the transfer of ownership from a third-party (e.g., grandparent) to the parent, but; beware that some states prohibit the transfer of a 529 account unless the owner dies and the transfer is mandated by court order (ref 14,15)
- 529 Plans started in year 2018 can be used to pay qualified educational expenses for primary, secondary, and postsecondary school. Misuse of the Plan for unqualified expenses will incur a financial penalty. 529s started before 2018 cannot pay for primary and secondary education; only the Coverdell ESA will pay those expenses (ref 12).
- The maximum investment is several-to-many hundred-thousand dollars depending on the specific plan. The total contributions may not exceed an amount needed to pay qualified education expenses of the beneficiary. The federal gift tax exclusion allows a tax-free limit of $14,000 ($28,000 if married, filing jointly) on annual contributions.
There are other tax-advantaged ways of saving for college (ref 12,16):
- Coverdell Education Savings Accounts receive favorable tax treatment on investment returns when used to pay qualified educational expenses from kindergarten through college. Eligible owners who file joint tax returns must have a modified adjusted gross income below $220,000. Their contribution limit is $2,000 per year up to the student’s 18th birthday (no more after age 18) and the account must be used before the student’s 30th birthday. Owners may change the Coverdell account or its beneficiary (ref 12). Owners may also rollover the Coverdell to a 529 (ref 17).
- Education Bonds are U.S. series EE Savings bonds issued after 1989 or U.S. series I Savings bonds, both of which are purchased by someone at least 24 years of age. The earned interest is tax-free if the benefiiciary is named as a dependent on the owner’s tax return, the owner’s modified adjusted gross income is below an acceptable limit, and the education expenses are qualified (ref 12).
- IRA distributions are tax-free when used to pay qualified educational expenses, but: beware that any educational withdrawals will severely impair the advantage of earning compounding returns for retirement savings.
Investments in mutual funds and custodial accounts (UTMA/UGMA) offer an unlimited opportunity for funding college. However, the balances reduce the student’s eligibility for financial aid and the returns are taxable (ref 16).
4. Scholarships and Grants
Scholarships and grants are awards of ‘free’ money to students that don’t require repayment. The application process demands time and effort by the high school student, but it’s well worth the effort (ref 18). Guidance counselors, reference librarians, and college financial aid officers are excellent sources of help. Free listings can be found online (ref 19,20).
5. Family Income
Students from high income families can rely on parents for financial help. Otherwise, they may need to earn money to pay for college. The work-study programs offered by colleges and private employers are good opportunities for students with a financial need (ref 21).
Student loans can delay college graduates from saving for retirement, a mortgage, and other big projects (ref 22). Still worse is the possible financial stress of paying a large debt (ref 9). Therefore, use student loans as a last resort. Federal student loans are generally the cheapest and safest when offered by the college financial aid office (ref 21).
Third parties (e.g., grandparents)
The student’s immediate family and the college are counterparties to each other when it comes to paying for college. Grandparents, relatives, and friends belong to the category of third parties. Third parties are valuable sources of financial aid under the right circumstances:
- Gifts less the $14,000 per year ($28,000 if married filing jointly) are exempt from the federal gift tax. A special exemption of $70,000 per donor may be paid as a one-time, five-year gift to a 529 savings plan (ref 14).
- Gifts are excluded from the gift tax when they bypass the family as direct payments to the college. Unfortunately, direct payments are counted by the college as “other income” that may disqualify the student from future aid. The disqualification is not a practical concern during the student’s final year of college (ref 14,15).
- Indirect payments to the family are likely to reduce the student’s eligibilty for need-based financial aid by inflating the “expected family contribution” (“EFC”) toward college expenses. The inflation of EFC is less when gifts are paid to the parents instead of the student. The best strategy for indirect payments is to contribute to a 529 savings account owned by the parents with the child as the beneficiary (ref 14, 15).
- A 529 account owned by a third-party does not inflate the EFC until payments are made toward the student’s college expenses. To avoid inflating the EFC, the third-party owner should transfer their account to the parents before the student applies for college. Beware that some states prohibit the transfer of a 529 account unless the owner dies and the transfer is mandated by court order (ref 14,15).
- Money borrowed by parents does not hurt their student’s chances for financial aid. Third parties can plan to make a legitimate loan to parents that includes a charge for interest. Once the parents are done paying for college, the third party has the option of forgiving the loan (ref 15).
Parents and grandparent-guardians should both avoid dipping into retirement savings to pay for a child’s college education. Instead, the child can earn income and apply for student loans.
Families who want professional help with the process of paying for college can hire a financial aid consultant. Before hiring a consultant, review the excellent advice given in references 23 and 24.
Students are required to submit a Free Application for Federal Student Aid (FAFSA) one year before attending college. Some colleges also require students to submit a CSS/Financial Aid Profile. The FAFSA and CSS Profile reveal how much a student can pay without borrowing money. It’s best if the student, with the help of the family, pays without borrowing.
1. Getting College Credit Before College. BigFuture, https://bigfuture.collegeboard.org/pay-for-college/college-costs/getting-college-credit-before-college.
2. Christina Tyman-Wood, What is an early college high school? https://www.greatschools.org/gk/articles/early-college-high-school/ , 3/7/2016.
3. Start college early. Rise Out, Inc. http://www.rise-out.com/start-college-early/ .
4. Taking Credit: How to Make Sure Your Course Credits Transfer When You Do. College Affordability Guide., https://www.collegeaffordabilityguide.org/transfer-credit/ .
5. Managing College Costs. College Resources. https://www.mycollegeoptions.org/Core/SiteContent/Students/Advice/College-Resource-Center/For-Parents/Paying-For-College/Managing-College-Costs.aspx .
6. 10 Ways to Reduce College Costs. Education Planner Org. http://www.educationplanner.org/students/paying-for-school/ways-to-pay/reduce-college-costs.shtml.
7. How to Choose Dream, Target, and Safety Schools. https://www.princetonreview.com/college-advice/dream-match-safety-schools .
8. College Affordability and Transparency Center, U.S. Department of Education. https://collegecost.ed.gov/catc/
9. Mark Kantrowitz, It’s cheaper to save than to borrow, Saving For College, 4/27/2018. https://www.savingforcollege.com/article/it-s-cheaper-to-save-than-to-borrow .
10. Mark Kantrowitz, How to save for a child’s college education before the child is born, Saving For College, LLC. College Savings 101, https://www.savingforcollege.com/article/how-to-save-for-a-child-s-college-education-before-the-child-is-born , 4/5/2018.
11. Frequently Asked Questions About 529 Plans, ICI Investment Company Institute, ici;org, https://www.ici.org/pubs/faqs/ci.faqs_529.print , 2014.
12. Tax Benefits for Education. Publication 970, Tax Benefits for Education, Department of the Treasury, Internal Revenue Service, https://www.irs.gov/forms-pubs/about-publication-970 , 1/31/2018.
13. Joseph F. Hurley and Brian Boswell, 2018-2019 Family Guide to College Savings, Saving For College, LLC. www.savingforcollege.com , 2018.
14. Robert Farrington, The Smart Way Grandparents Can Help Pay For College, Forbes/Education. https://www.forbes.com/sites/robertfarrington/2014/10/13/the-smart-way-grandparents-can-help-pay-for-college/#69ad07a17927 , 10/13/2014.
15. Safe Ways for Grandparents to Help with College Costs. Dowling & Yahnke, LLC. https://www.dywealth.com/resources/blog/safe-ways-grandparents-help-college-costs
16. Kathryn Flyn, 6 ways you can save for college. https://www.savingforcollege.com/article/6-ways-you-can-save-for-college , 9/1/2018.
17. Kathryn Flynn, When to consider a Coverdell ESA to 529 plan rollover. June 26, 2018. https://www.savingforcollege.com/article/when-to-consider-a-coverdell-esa-to-529-plan-rollover , 10/9/2017.
18. Kristina Ellis, Confessions of a Scholarship Winner. Worthy Publishing, Brentwood, 2013.
19. Scholarships. College Scholarships Org. http://www.collegescholarships.org/scholarships/ .
20. Finding and applying for scholarships. www.studentaid.gov/scholarships.
21. Federal Student Aid, U.S. Department of Education. https://studentaid.ed.gov/sa/.
22. Matthew S. Rutledge, Geoffery T. Sanzenbacher, and Francis M. Vitagliano. How Does Student Debt Affect Early-Career Retirement Saving? Center for Retirement Research at Boston College, May 2018. http://crr.bc.edu/wp-content/uploads/2016/09/wp_2016-9_rev.pdf.
23. Evaluating Financial Aid Consultants. http://www.finaid.org/scholarships/consultants.phtml .
24. Deborah Ziff, Decide if you need a private financial aid consultant, usnews;com, https://www.usnews.com/education/best-colleges/paying-for-college/articles/2017-07-05/decide-if-you-need-a-private-financial-aid-consultant , 7/5/2017.
Copyright © 2018 Douglas R. Knight
My Nov. 7, 2017, inaugural column for The Dispatch, “Civics education in schools needs reboot,” noted there are “loud” and “quiet” crises. An example of the latter is the decline in civic literacy, or basic knowledge of how our government works.
Another and equivalent crisis in the quiet category is financial literacy. For years, numerous polls and studies have revealed how little millions of Americans know about the basics of personal finance and investing.
A 2015 study of more than 27,000 people by the FINRA Foundation estimated nearly two-thirds of Americans could not pass a basic, five-question quiz covering credit, interest, diversification in investing, and inflation. Disturbingly, the percentage of those who passed had fallen from 42 percent in 2009 during the financial crisis.
Results of a survey of six age groups released in January by the National Financial Educators Council estimated that lack of knowledge of personal finance cost America more than $280 billion in 2017.
To compound the issue, we’re living in a consumer-driven society in which spending, especially for immediate gratification, is far more emphasized than saving and investing. The proof: the U.S. household savings rate decreased to 2.90 percent last November, the lowest rate since just before the Great Recession and near the record low of 1.90 percent in July 2005.
At a time when the millennial generation, the largest demographic group in history, enters its prime years of spending, saving and investing, it’s critical for that generation, as well as all Americans, to improve their financial literacy, especially before the next recession arrives.
How can poor financial literacy, an Achillles’ heel, be turned into a personal and national strength?
‒ As with physical fitness, financial health begins with good habits, and good habits begin in the home. Surveys have clearly shown that students who talk to their parents about money matters were more financially literate than those who did not. Parents must serve as models for disciplined spending and savings, educating their children along the way about the long-term value of such habits. Instead of lavishing their young with holiday or birthday gifts, they could open a savings account for them and make the first contribution to them to spark a savings mentality. Parents lacking financial literacy can access many online programs, including one offered by the American Bankers Association via its “Teach Children to Save Day” every April.
‒ Making saving as automatic as possible is the best way to build wealth and remove much of the temptation to make impulse buys. Those with little margin for savings can invest spare change through micro-investing apps such as Acorns. Those belonging to 401(k) plans or who have Roth IRAs should have the largest contributions possible deducted from their paychecks after accounting for the payment of truly necessary monthly expenses.
‒ Just as making civics classes mandatory in the classroom can develop more-informed voters, so too can requiring students to master a class in personal finance enable financial literacy before adulthood. Online courses in financial literacy could be customized for different grade levels for secondary schools. Many financial institutions that sponsor and promote financial-literacy programs could collaborate with teachers, quasi-governmental bodies, Junior Achievement, and other organizations to design such courses. A good governmental resource to build such courses can be found at https://www.mymoney.gov, which focuses on “The Five Principles” of Earn, Save & Invest, Protect, Spend and Borrow.
‒ Financial institutions also can educate young investors by sponsoring and promoting social events featuring crowd-sharing tips. Nothing motivates young people more than peer recommendations, and informal, free events featuring financially savvy young adults as ambassadors for financial literacy could be an effective grassroots-based tool. A good opening topic for an informal discussion could be credit scores, which many millennials are extremely interested in building and protecting.
Not coincidentally, April is “Financial Literacy Month,” the time when tax filings are due, 401(k) plans for the previous year must be established and funded and when many Americans receive tax refunds. Given the impact of the tax-cut bill and the opportunity some have for increasing savings in 2018, we have an ideal opportunity to reverse the trend of financial illiteracy and strengthen our financial future.
Jim Simon, is a central Ohio resident and former chief communications officer of several corporations.
Jim Simon: Financial literacy is America’s Achilles’ heel – Opinion ( – The Columbus Dispatch – Columbus, OH, Thursday, 2/1/2018.
Copyright © 2018 Jim Simon
Children have the gift of time for building their future. Unfortunately, thousands of young people waste their early opportunity to start building an emergency fund, saving for adulthood, and investing for retirement. Here are 3 examples:
A neighbor who finished the first year of college with a 3-point average (good grades!) decided to move to New York to find a job and live with her sister. This was not surprising when considering that she used to sell stuff door-to-door to earn money. What surprised me was that she asked if we had any advice? “Yes”, I said, “invest in a Roth IRA”. “What’s a Roth IRA?”, she asked. Neither she nor her college-graduate parents knew about IRAs.
Two grandmothers told me on separate occasions that they wished their young adult grandsons would invest in the stock market.
References 1 & 2 describe the problem and correction for delinqent investing.
- Tanisha A. Sykes, This 30-something investor isn’t freaking out about her 401(k) — she’s catching up, 7/5/2017, https://www.usatoday.com/story/money/2017/07/05/young-investors-late-bloomer/103394004/
- Wayne Pinsent, 5 common mistakes young investors make (updated 5/21/18): https://www.investopedia.com/articles/younginvestors/09/common-mistakes-young-investors.asp
Copyright © 2018 Douglas R. Knight
Children have the advantage of a long TIME-period for investing toward college and retirement. Family teamwork is essential to that process and grandparents can be an integral part of the team.
This presentation will explore ways that seniors can facilitate their grandchildren’s long-term investments. In viewing my presentation, please understand that I am not a professional financial advisor; I merely advocate frugal, do-it-yourself investing for all ages. I would like to emphasize the following thoughts:
- Young investors have the advantage of TIME. Will they use it wisely?
- Becoming informed investors starts at home with the family traditions of money management.
- Save for retirement? Form the savings habit early in life.
- College is any certified program of higher education. Paying for college requires ‘college prep’.
- Grandparents have the resources to help young investors and college students.
The Advantage of TIME
The advantage of TIME is to help build wealth by reinvesting dividends and capital gains. Those reinvestments promote the growth of a long-term investment project. The black growth curve in chart 1 predicts the future value of $1 invested in the stock market. The colored dots represent the increasing value of the invested dollar with the passage of time. This method of growth is called compounding interest or compounding returns. Notice that,
- the growth of $1 to $3.40 in 18 years is a predictable outcome of saving for college.
- the growth of $1 to $30-$114 in 50-70 years is a reasonable outcome of investing for retirement.
Wise money-management is an essential skill for investing successfully and protecting those investments. Money management may be a family tradition or a new family experience. Either way, children usually start forming money habits early, before entering elementary school. Many families teach the wise management of money by encouraging their children to store money in jars.
- the spending jar facilitates decision-making. Children love money and typically don’t have enough to pay for everything. They should learn to spend wisely and accept the consequences of their choices. If they borrow money, they should learn to pay it back on time.
- the saving jar helps make future payments. Saving leads to investing. Help them save for short term goals and encourage them to gradually save larger amounts over longer time periods. Introduce them to the stock market. Consider helping them to buy shares of stock issued by their favorite company.
- the sharing jar builds community awareness. Expose children to the needs of others in their community. Sharing money and volunteering to work will cultivate relationships and humane values.
Young children dream about becoming grown-ups. They wonder what adults do for a living and how parents earn incomes. Older children are inspired by classmates, adult role models, field trips, group activities, etc. Family support can help transform these imaginations and inspirations into simple financial goals. Examples of dreams (chart 3):
- teenagers want expensive things like cars and computers.
- young adults think about weddings and buying a home.
- The habit of saving for retirement can be inspired by dreams of becoming millionaires. [My granddaughter read a story in her favorite magazine about saving to become a millionaire. She was fascinated. I discussed the article with her and shared her excitement. I asked her mother (my daughter) if I could provide some seed money to open an investment account at a reputable brokerage firm. A year or so later, my granddaughter started earning money as a tutor and used her earnings to open a Roth IRA. She enjoys reading her financial statements and watching her investments grow in value.]
Financial markets have cycles of market prices that expose investors to the risks of profits and losses. How willing are you to risk the loss of money from an investment compared to its potential profit? Compared to bonds, stocks are high risk, high return investments. It’s very reasonable to expect a good profit from the stock market after 30 years! Children have the advantage of waiting 30 years for a profit after investing in the stock market. Therefore, they can tolerate more risk compared to someone entering retirement.
Finance is the art of putting money to good use. Simple financial plans have an approximate time interval (short-term or long-term), the desired item (chart 3), and a funding method.
- Short-term plans are usually low-risk, low-return projects
- low-risk refers to dependable investment returns and guaranteed repayment of invested money
- low-return refers to low rates of return (e.g., 4% interest rate from high-grade bonds)
- Long-term strategies are suitable for high-risk, high-return investments
- high-risk suggests a good chance of either earning or losing money from an investment
- high-return suggests a higher rate of return than earned from high-grade bonds
Chart 5 summarizes several well-regulated investments for FUNDING desired items. I would like to emphasize that saving and investing are the best ways of avoiding the hazards of debt.
‘Good’ debt is cheaper than ‘bad’ debt. Lenders of good debt require an acceptable credit rating before lending money at a competitive interest rate and reasonable maturity date. Student loans are usually reputable when brokered by college financial aid officers to pay for college costs. Beware: Students can incur high debt by borrowing for extra years of college or attending elite schools. High debt can cause emotional and financial distress.
Informed investing involves selecting the right type of investment, using a frugal method of payment, and forming a plan to protect the investment. Short-term investments (chart 5) have time periods of 1-5 years. The following investments are guaranteed to pay small amounts of interest in addition to returning the investor’s money at a time called the maturity date:
- money market funds
- certificates of deposit
- government bonds that mature within 1 year
Long-term investments (chart 5) have time periods that extend beyond 5 years.
- Stocks are certificates of ownership in a company that guarantee the shareholders a claim on the company’s profits. Stockholders earn returns from dividends and capital gains. The expected long-term return is an average annual rate of 7%. There are no guaranteed returns.
- Bonds are contracts that guarantee scheduled payments of interest and repayment of the invested money. The expected long-term return is an interest rate of 4%.
- REITs are real estate investment trusts that must distribute at least 90% of the trust’s annual profit to its shareholders. There are no guaranteed returns.
- Investment funds are pooled investments, typically stocks or bonds, owned by a group of investors. Funds pay interest, dividends, or capital gains to shareholders in proportion to their share of the investment fund. Shareholders also earn capital gains by selling their shares of the investment fund. There are no guaranteed returns.
- Mutual funds and ETFs are investment funds governed by the Securities and Exchange Commission (SEC) for the benefit of investors.
- 529 Plans and Roth accounts are portfolios of government-regulated, tax-advantaged investments. 529 Plans are only used as an educational savings plan. Roth accounts are used as a retirement savings plan, but may also be used for the qualified expenses of an education or purchase of a first home.
Frugal investing enhances investment profits by minimizing the impact of fees and taxes. Chart 6 summarizes the traditional ways of investing frugally in stocks and investment funds.
- Trading fees: An investor must pay trading fees for every purchase and sale of stocks or investment funds unless otherwise enrolled in a direct purchase plan or no-fee plan.
- Automatic reinvestments: Many stock brokers will automatically reinvest their client’s investment returns for free if the shares are already owned.
- Dollar-cost-averaging is the practice of investing a fixed amount of money in a stock or investment fund at regular time intervals, typically every month. The advantages are those of having an affordable investment plan and the freedom from worrying about fluctuations in market prices. The potential disadvantage is that trading fees can dilute the investment profits. Some companies and brokers support dollar-cost-averaging by excluding trading fees.
- Taxes: Investors must pay federal income tax on investment returns. The Kiddie tax is a provision that excludes children from paying taxes on the first $1,050 of gross income, including investment returns. Nor do children don’t pay taxes on investment returns they acquire in a tax-advantaged education savings account (e.g., “529”) or a Roth IRA.
In childhood, the first serious step toward planning for retirement begins with forming the habit of investing in stocks (chart 7). The prospect of getting ‘rich’ is a strong (but temporary) motivation. Grandparents could help with the investment program. The child investor might have to pay a “Kiddie tax” on investment returns until they can open a custodial Roth IRA. As soon as they start earning income from outside the family, and report that income to the Internal Revenue Service (IRS), they are eligible to open a Roth IRA that can then be used for a lifetime. It’s also important to teach children about the tax-advantaged retirement account known as the employer-sponsored 401(K) plan.
TIMELINE FOR RETIREMENT SAVINGS
- introduction to stocks during pre-teen years
- teens who earn income from any legitimate employer outside their family can open a Roth IRA
- qualified withdrawals will not be penalized or taxed
- qualified withdrawals are restricted to paying education expenses, making a partial payment to buy a first house, people with disabilities, and people over the age of 70 ½ years.
- employed young adults can participate in employer-sponsored (e.g., 401(K)) or self-employed (SEP) retirement accounts. The contributions are deducted from salaries and may be supplemented by the employer. It’s important to enroll as soon as possible and participate to the fullest extent.
- dollar-cost-averaging is the habit of making regular monthly contributions to an investment plan to help protect against fluctuations of the stock market.
Colleges are institutions of higher learning (beyond high school) that are certified trade schools, 2-year community colleges, 4-year schools, graduate schools, or professional schools. College prep is a family enterprise aimed at preparing students for higher education. The family’s financial goal is to balance the cost of higher education with an equal amount of savings and scholarships (chart 8).
Financial aid is used if needed. Grants and work-study programs are types of financial aid that don’t incur debt. Student loans are financial aid that incur ‘tenacious’ debt.
Unlike consumer loans, student loans can’t be cancelled by declaring bankruptcy. The 3 ways of cancelling a student loan are 1) payment-in-full, 2) debt-forgiveness for performing public service, or 3) death of the borrower.
TIMELINE FOR ‘COLLEGE PREP’:
- start early; age 1 or as soon as possible.
- the Coverdell and 529 Plan are tax-advantaged educational saving accounts that work best when owned by an adult for the benefit of the student.
- grandparents can contribute to their family’s educational savings accounts and help motivate their grandchildren to seek higher education.
- the required savings can be estimated with the help of net-price and affordability calculators available for free online.
- Scholarships are debt-free awards of money to students based on eligibility and possible conditions of student performance required by the sponsor. Tips for seeking a scholarship:
- applications for relevant scholarships are the responsibility of the high school student
- require considerable research and effort by the student applicant
- start research in first or second year of high school
- academic achievement is important, but not the only factor considered by many sponsors
- try to accumulate large awards by seeking several relevant scholarships
- grandparents might help with the research, proof-readings, practice interviews, travel costs, etc.
- Cost of attendance is provided in college web sites. Several ways of reducing the cost are:
- high school student may be able to enroll in “early college”
- college credit may be earned by successful performance in advanced placement courses and CLEP exams.
- more expensive 4-year colleges may accept transcripts from less expensive 2-year colleges.
- apply for admission to a “financial safety” college that offers a quality education
- Financial Aid is offered by the college’s financial aid officer after the family completes the necessary application forms for enrollment.
- submit the forms before, not after, the deadline; early submissions are ‘first in line’ for review by the college and many colleges have a limited amount of un-loaned aid.
- expect to complete and submit a Free Application for Federal Student Aid (FAFSA) and College Scholarship Service (CSS) Profile. Both forms are detailed, lengthy, and inquisitive.
- Government student loans are generally preferred to private loans. Federal subsidized loans for deserving students with financial need have additional financial benefits.
- Government grants are special scholarships offered to deserving students with financial need.
- recommendation: apply for financial aid even it is unnecessary. The family could still incur a financial disaster during the next school year.
EFC: The student’s annual financial aid (AID) is computed by subtracting the expected family contribution (EFC) from the annual cost of attendance (COA). The EFC is determined by authorities who review the FAFSAs and CSS Profiles on behalf of college admissions officers. Aside from the EFC, there are net price calculators available online that can help families estimate their college payment and financial aid package before completing the FAFSA and CSS Profile applications.
The EFC computed from the FAFSA is derived from an impartial assessment of the family’s income and assets. The assets are various savings and investment accounts aside from the parents’ retirement savings plans. Parents are expected to pay 6% of their assets and dependent students are expected to pay 20% of owned assets. Parents are also expected to pay 22-47% of their annual income (depending on financial circumstances) while dependent students are expected to pay 50% of annual income. FAFSA offers an annual automatic income allowance (~$6,000) to be excused from the child’s reported income. Independent students who are married or further along in life are assessed differently than dependent students. The CSS Profile’s EFC is somewhat different based on different policies.
Financial gifts from grandparents and other third parties may reduce a student’s need-based financial aid by inflating the EFC. Chart 9 enumerates the ways that cash gifts can affect the eligibility for financial aid.
There are several good ways for grandparents and other third parties to help students prepare for college (chart 10). Some ways may reduce the student’s eligibility for financial aid as just mentioned for chart 9. Other ways help inspire the student to attend college and graduate with a useful education. Contributions to parent-owned savings plans have much less impact than contributions to student-owned savings. Health insurance and student loan payments will help recent college graduates.
- Children must learn to spend wisely in order to avoid future financial insecurity
- Saving and investing are the best ways to finance goals. Investing starts at home!
- Parents and grandparents can help children transform dreams into financial goals and plans.
- Effective “ college prep” will create opportunities. “College prep” should be a family commitment AND the high school student’s responsibility.
Copyright © 2018 Douglas R. Knight
Moderator’s Introduction, Douglas R. Knight
The goal of this workshop is to discuss ways of helping grandchildren invest for college and eventual retirement. Grandparents have the time, experience, and resources to help those investments.
My role as moderator is to introduce today’s topics. Mr. Eric J. Robbins will then describe ways of investing in your grandchildren’s future. Eric is a senior investment advisor at Buckeye Wealth Management with over 30 years of experience in the financial services industry. Finally, Mr. Jefferson R. Blackburn-Smith will suggest ways of preparing grandchildren for college. Jefferson is Otterbein University’s Vice President for Enrollment Management.
The reinvestment of stock market returns is the preferred method of saving for college and retirement (chart 1). “College” is any certified program of higher education at trade school, the 2-year Associates degree, the 4-year Bachelors degree, graduate school, or professional school. Family savings, student scholarships, and financial aid are principal sources of funding to pay the cost of college. There are also ways of reducing the cost of college. Paying for college deserves early planning.
Chart 2 shows 3 goals for gradually improving children’s knowledge of personal finance.
- The first goal, financial training, is an important program which is best taught at home by parents. The topic of money for pre-school children is an ideal place to start. Proper management of money will become the child’s most important skill for personal finance and college preparation.
- The second goal, “college” graduation, is headed for success when parents start saving for college early-and-often in a 529 plan. Grandparents can contribute funds to the 529 and also help nurture the lives of their grandchildren. Grandchildren thrive on dreams, experiences, and skills to help prepare for college. Well prepared students are those most likely to graduate from college with a useful education. “College prep” refers to the high school student’s tasks of choosing colleges, obtaining scholarships, and reducing the costs of college; guidance counselors and librarians are excellent resources. Negotiation is the process of comparing college acceptance letters and seeking the best financial terms of paying for college. Excessive student loans can be a disturbing financial burden after graduation.
- The third goal, secure retirement, begins when grandchildren start saving for expensive things; those things become more expensive as a child’s interest shifts from toys to stylish clothes, electronic devices, and cars. Bank accounts offer security to a child’s savings. A grandparent can help grandchildren buy a stock and then periodically review its performance; it’s an excellent introduction to the world of finance. Jobs help grandchildren form entrepreneurial ideas. The taxable earnings can be deposited in a custodial Roth retirement account. Grandchildren need to be encouraged to save taxable earnings in the Roth account as a matter of habit. All children need safety lessons to avoid truancy, cyber attacks, gambling, credit card debt, and other risks to their wealth and health.
After college, young adults should enter the workforce even if their first job is not a ‘dream job’. Job success will enhance their future workforce mobility.
Investing for Your Grandchild’s Future. It’s Never Too Early to Start, Eric J. Robbins
The key points of my talk are:
- college is an expensive investment that often incurs debt
- grandparents’ financial assets are not detrimental to student eligibility for federal financial aid
- families have many ways of saving for college; among them are several tax-advantaged savings programs
- parents and grandparents should avoid making 4 big mistakes when paying for college
- careful planning will reduce expensive mistakes
The average cost of college tuition and fees in 2017-18 varied from $9,970 [for in-state public schools] to $25,620 [for out-of-state public schools] and $34,740 [for private colleges]. To cover these costs, my recommendation is to start a college payment plan early! Otherwise, a large debt from student loans could cause significant financial distress after graduation from college. The average cost of student-loan debt is $351/month (chart 3).
In general, students use loans to pay for 19% of college costs and parents borrow an additional 8%. Grandparents typically pay no more than 4% of college costs (chart 4)
College students are required to submit a FAFSA form (chart 5) to the college admissions office when applying for federal financial aid. High-income families with large savings accounts (“assets”) receive less federal financial aid than low-income families with small accounts. For a given amount of family assets, larger portions of student savings attract less federal financial aid. Grandparent-owned assets are invisible and have no effect on federal financial aid (chart 5).
Families have many ways of saving for college (chart 6)
Qualifed series EE savings bond, 529 savings plans, Coverdell IRAs, and Roth IRAs are protected from federal taxation of investment returns. Chart 7 offers a useful comparison of these tax-advantaged plans with taxable custodial accounts.
Several comments about chart 7: Investment returns are not taxed except in the UGMA/UTMA accounts; annual income limits may restrict participation in the Roth and Coverdell accounts; contribution limits to all accounts are regulated by the government except for the UGMA/UTMA; untaxed returns can be withdrawn for qualified educational expenses (UGMA/UTMA returns are always taxable); account owners are allowed to change the student beneficiary in all but the UGMA/UTMA accounts; account owners or custodians are generally allowed to control the account with some exceptions; non-FDIC investments are not guaranteed (but why invest in a low-return FDIC account for long-term growth of savings?)
The reason for having a college savings plan is avoid mistakes that lead to unnecessary personal losses. The biggest mistakes that parents and grandparents make are shown in charts 8-11.
If a parent waits 5 years before starting to invest $200/month, the $17,380 opportunity-cost of waiting to invest would decrease the final savings balance to $13,680 instead of $30,998 (chart 9). If the parent initially invested $10,000 and then waited 5 years before investing $200/month, an opportunity cost of $29,885 would reduce the final balance to $64,906 instead of $94,791.
Additional mistakes are: failing to plan for college; allocating college savings and other financial assets to the student instead of the parent; and, no planning for possible investment losses.
Families can reduce financial mistakes for college by gathering useful information (chart 12), selecting a suitable investment return (chart 13), and seeking alternative sources of funding (chart 14).
Helping Grandchildren Invest: Strategies for College, Jefferson R. Blackburn-Smith
The agenda for my talk:
- some truths about college
- savings strategies
- controlling cost
Many families aren’t prepared for college. Here are four ‘truths’ that college-student families need to know:
Truth #1: College is worth the effort of careful planning (chart 17). Grandparents can help by promoting the opportunities of a college education.
Truth #2: College is expensive but few students pay the full price (chart 18). For example, students can seek grants and scholarships that reduce their payments.
Truth #3: The student debt crisis needn’t be as bad as reported by the media (chart 19). Low-income students tend to borrow more carefully, high-income students less carefully.
Families can shop for government and private student loans with the best interest rates and repayment plans. College graduates might choose to participate in debt-forgiveness programs by seeking employment in certain public service programs.
Truth #4: Cost, quality, and educational outcomes are important factors to consider in selecting a college (chart 20).
One way of paying for college is to distribute the expenses equally among 3 financial accounts (chart 21).
Among ways of paying for college, an educational savings account works best when started by an adult early in the grandchild’s life. Grandparents can encourage their family to open a savings account and then make contributions to that account (chart 22).
There are many advantages to using a 529 college savings account owned by parents (chart 23).
In comparison, student-owned savings accounts may be taxable and could reduce the student’s eligibility for financial aid (chart 24).
Student performance and lifestyle have a signficant impact on the cost of college. Roughly half of Ohio’s 4-year college students graduate on time, which means that the other half are either dropping out or paying much more to graduate. In chart 25, “Lifestyle” borrowing refers to students paying for unnecessary college expenses such as extravagant vacations.
- Grandparents have the time, experience, and resources to help prepare grandchildren for college and retirement.
- Continual reinvestment of stock market returns is recommended for college and retirement savings plans that are started early in the grandchild’s life.
- Protect college and retirement savings in a tax-advantaged education account (e.g., 529 plan) and retirement account (e.g., Roth IRA).
- Help grandchildren acquire the lifetime habit of saving for retirement
- Help grandchildren channel their dreams and experiences into goals for careers and adult life; college could help them achieve those goals.
- Many families are unprepared for college. Early planning and careful preparation will reduce the cost of graduating from college.
- Minimize student-loan debt by starting a 529 plan early. Other ways of minimizing student debt include grants & scholarships, work-study programs, reduced college expenses, and loan forgiveness programs.
[additional references are listed in the LITERATURE page of this blog]
Copyright © 2018 Douglas R. Knight, Eric J. Robbins, and Jefferson R. Blackburn-Smith