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In this episode of the Science of Economic Freedom, “How to Fund College without Going Broke,” I speak with Jamie Block, Certified Financial Planner, CPA and client advisor with Mercer Advisors.
Jamie is an expert at helping clients prepare for, and fund, their children’s college educations. She’s helped hundreds of clients make the right choices for not only college funding, but also for funding their own economic freedom.
Issues covered in this episode include:
Jamie was a wealth of knowledge on the topic of college funding, so if you or anyone you know have a child or grandchild that needs college funding, then this episode of the Science of Economic Freedom is a must.
Doug: Are you ready to fund your child’s college education? Do you have family that should be planning for college? Are you aware of all of your options for funding college? This week on the Science of Economic Freedom certified financial planner Jamie Block joins the discussion to share her wisdom on college funding.
Announcer: The Science of Economic Freedom is intended as an investor education resource. The views and opinions expressed on this program should not be construed as a recommendation to buy, sell, or hold any specific security. Consult your investment advisor and read any investment perspectives carefully before making any changes to your investment portfolio.
This program is sponsored by Mercer Advisors. Mercer Global Advisors Inc is registered with the Securities and Exchange Commission and delivers all investment-related services. Mercer Advisors Inc is the parent company of Mercer Global Advisors Inc and is not involved with investment services.
Doug: Welcome to the Science of Economic Freedom. I’m your host, Doug Fabian. This podcast is all about helping you achieve your financial dreams. We call that economic freedom. This program is about your journey to achieve economic freedom for yourself and your loved ones.
Today we want to help you identify your next step on that journey. This is episode 34, How to Fund College without Going Broke. As a parent of six, I get it. Four have gone through college, I’ve got two more in the pipeline, and I know about my personal experiences and will share them today as it pertains to helping you fund college without going broke.
Joining me today is another expert on financial planning, cash flow, and taxes, Jamie Block. Jamie knows how to plan for college funding. She has helped hundreds of clients make the right choices, not only for college, but for their economic freedom as well. Jamie is passionate about helping others achieve economic freedom. She shows her passion with years of experience and with her volunteer work, serving as treasurer on numerous nonprofit boards. She is also an EMT volunteer as well. Jamie has two kids, one entering college this year and another a few years away. Here’s my interview with Jamie Block.
Jamie, welcome to the podcast.
Jamie: Thanks for having me on here, Doug.
Doug: Jamie, before we jump into the subject of college funding, I wanted to talk a little bit about you and have the audience get to know you a little bit. You were a CPA before you became a certified financial planner. Why did you choose planning when you had the CPA credential?
Jamie: That’s a very interesting question. So, when I was in the CPA firm, you do a lot of work after the fact, your tax return, your audits and so forth, and I was seeing clients with huge tax bills and things of that nature, and I thought, “Boy, we could really help these folks if we planned ahead of time, didn’t help them that way.” Unfortunately, CPAs get paid by the hour and nobody wanted to pay for that advice. So, that’s kind of where I transitioned into financial planning. We’re more proactive instead of reactive to the client’s needs.
Doug: And that leads us kind of into your passion about planning and client finances. How do you begin a conversation with a client, to get to know them, to try to get some energy going, to understand their goals?
Jamie: Sure. First thing I like to do is talk about their family, you know, where they grew up, hold old their parents are, how many kids they have, and what their goals are. Do they want to have a legacy for their children? Do they have elderly, aging parents that need care? Do they need to retire early or have that desire? And then we take it from there and then figure out how that correlates to their financial freedom.
Doug: So, let’s transition into this whole discussion about college funding without going broke. Now, have you ever heard of college funding ruining retirement for a family?
Jamie: Unfortunately, I have. I’ve heard many horror stories about individuals taking money out of their retirement plans prematurely. They pay taxes and penalties on it because they’re under 59 and ½ years of age and they use that money to fund their children’s college. So, therefore, when they go to retire, they have nothing to live on. Therefore, they have to work even longer and not retire when they really wanted to.
Doug: What are the mistakes that I sometimes see happen with families, and again, I’ve had the experience you have. Your oldest son’s starting to enter college. I’ve put four kids through college. You know, you really have to have that discussion with the kids about where you’re going to school, and what it’s going to cost, and should you go out of state, and those kinds of things.
I would encourage everybody who’s listening to this broadcast to make sure that they’re having frank discussions with their children about what they can afford or what they can’t afford and what’s right for the family and what’s right for the kid, and making sure that you’re keeping your own priorities intact.
So, Jamie, when it comes to families and making mistakes relative to college funding, what mistakes have you seen?
Jamie: Well, what I’ve seen is individuals coming to our office saying, “My child is going to be going to college in two years. How do I pay for it?” And at that point, you’ve already lost many years of compounding that you could have earned on investments and save additional money for this child’s education expenses. And, once you get two years before college, you don’t have that time. So that’s one big mistake I see that families make, is just waiting too long to save for education expenses.
Doug: And when you think in terms of the big takeaway from our show today on funding college, how would you summarize that before we get into specifics?
Jamie: Yeah, the big thing is to start early and make sure you have a plan in place. It doesn’t have to be extravagant and super-detailed to the penny. Obviously, plans evolve and change, but you need to start somewhere, so start with a plan, start saving early and make sure you do not sacrifice your retirement for your kid’s education costs.
Doug: Now, we have a tool that may be known to most of our audience, to be able to save for college. It’s called a 529 account. Explain how this works.
Jamie: This is a tax advantage savings vehicle that you can use for educational costs. It can be opened by parents, grandparents, friends, or relatives, and you can put in about $15,000 a year, up to, per person. So, spouses could put in $30,000 a year without filing a gift tax return. And these are great vehicles because you can use this money for education tax-free. So, with the money you put in, plus any earnings made on it, can come out, used for education tax-free.
Doug: Now, wasn’t there a change in the tax law relative to 529 plans, this most recent tax law?
Jamie: Yes, there was. So, prior to the tax law, you could only use these accounts for tuition for college education. Now, with this new tax law change, you can use it for kindergarten up through their senior year. My caveat on that is you have to make sure you check with your state, because in New York state, for example, they will take back any benefit that you’ve claimed by using this money for kindergarten through 12 years of education. So, double-check with your state before you do so.
Jamie: Yeah, that’s a great question. We see this all the time with clients that…they have multiple children. One child, maybe the oldest, decides they don’t want to go. The great aspect of these plans is that you can change a beneficiary to their siblings. And if the siblings all are gone through college or decide they don’t want to go, you can change it to grandchildren.
Worst-case scenario, if nobody decides to go to college, you can actually pull the money out, but then you’ll have some penalties and tax to pay on them.
Doug: And that penalty in taxes is relative to the growth on the account, or is there also an additional penalty for pulling money out of a 529 plan?
Jamie: It’s relative to the growth on the account. So, if you put $10,000 in and it grew to $15,000, then that $5,000 of appreciation you’d have tax in penalties on.
Doug: Let’s go back over that issue of tax deferral and really, in this case, we can describe it as tax-free growth, because if you save money in a 529 plan, you do get growth on those dollars over time and you go to exhaust the account to pay for college, which is the ultimate goal of what we’re talking about here today. There really are no taxes on the growth of those assets. Is that correct?
Jamie: That’s correct.
Doug: And so, that’s the whole idea, ladies and gentlemen, of using the 529 plan is to be able to compound tax-free… Now, it is tax-deferred if you don’t end up using the money for its purposes, but that’s what we’re trying to get everybody to understand. But there are some nuances with 529 plans. And, Jamie, many of them are linked to a specific state? Explain how that works.
Jamie: Right. So, for example, in New York…New York has a $10,000 tax deduction available to them if you donate to a New York state-approved 529 plan. So, each state has their own 529 plan you can donate to, but there’s also non-state specific plans you can get at brokerage companies like Charles Schwab and TD Ameritrade, for example.
Doug: So, we have this tax-free saving account called a 529 plan. This is similar to a 401(k) where there are investment choices that are specific to that plan. I want the audience to understand that you can’t buy Apple stock or a specific mutual fund in a 529 plan. You have to use the investments that are designated and attached to that plan. How are those investments usually set up, Jamie? Give us the landscape on that.
Jamie: Yeah. So, a lot of times you’ll see age-based options. So, if you start in an aggressive portfolio when someone is an infant, it’s going to be a lot more stock-based and as they progress to age 18 when they’re going to start to utilize this money, the allocation goes from a higher percentage of equities and stocks to a lower percentage to reduce the risk and make sure that their assets are going to not be subject to the volatility of the market and it’s going to be available for when they need it. So, these age-based options change as your child ages, which is nice because it kind of takes the thinking out of it for investors, because the funds themselves are going to evolve as your child ages.
Doug: Talk to us about… And again, my understanding that there could be 8 to 10 options in a 529 plan, 6 or 7 of those options could be these age-based strategies where they’re tied to a specific year that a child’s going to need the money. But then there is also a fixed-income option, a money market option, a…all-equity option. Is that correct?
Jamie: That is correct. And, one caveat to that is you want to make sure that you rebalance these accounts if necessary, as the market changes. So, if we have a good run on the market like we have, you might want to rebalance, take some of the gains from the equities and buy more bonds. Then, as your child ages, you also want to reduce your equity exposure just to reduce their level of risk.
So, you do have a lot of these options, but typically most individual investors use these age-based options because it’s kind of a no-brainer. You can set it and forget it, and the investments take care of themselves.
Doug: Jamie, talk to us about the power of compounding. I asked you to prepare some compounding examples, and what we’re talking about, ladies and gentlemen, is if you were to be saving a certain amount of money each month or each year, what would happen over the span of 15 to 18 years of compounding? So, Jamie, go through your examples.
Jamie: Sure. So, if you contribute $50 a month when your child is born until about age 18, and let’s assume about a 6% average annual return, at the age 18 you’ll have about $20,000 saved for your child’s education. Assuming we do $100 instead each month, we’d have about $39,000 saved. So, you can see that it really does pay to start early. Have a structured payment, so that way it’s automatic, and allow it grow tax-free for your child’s education.
Doug: Now, let’s circle back and just clarify for the audience what the uses of these plans are. Now, we have expanded the scope because of the 2018 tax law changes outside of just college tuition, and you had mentioned that you could use these dollars for private school for K through 12, but what other things can use you use 529 plans for in terms of funding?
Jamie: So typically you can use it for tuition as you had mentioned, but you can also use these funds for books, equipment such as computers, computer software, and services such as internet fees, and certain board and fees. But again, make sure you double-check that with your 529 provider if you’re uncertain.
Doug: And one of the things that people obviously have to be careful of is making sure that they do the right things with these dollars, because when you make a withdrawal from a 529 plan, and let’s just say a parent withdrew $5,000 and they were adding another $5,000 of their own money and they paid tuition. Are you just keeping accurate records on this? The money doesn’t have to go right from the 529 plan to the institution. Is that correct?
Jamie: That’s correct. You can actually get a distribution to yourself and then pay the tuition. You’ll get a form at the end of the year from the 529 plan stating you took that distribution, so you’ll just have to make sure you mark on your tax return that it was used for tuition versus a non-eligible expense and have to pay tax on it.
Doug: Now, ladies and gentlemen, we’re going to get into some other choices besides the 529 plan in just a moment, but just to kind of wrap up things on the 529 plan, Jamie, you prepared some, you know, kind of pointers or some guidelines or best practices for people. Go through those, please.
Jamie: Yeah. So as I said earlier, set up your 529 plan as soon as your child’s born. Earlier the better. All you need is a Social Security number and their name and then you can get these plans going. And some states, like I said, New York, allow a state tax deduction, so make sure you’re contributing to the appropriate plan. Make sure you verify the investment options. Again, if you want to have an [Phonetic 00:15:47] aggressive portfolio when they’re younger and less aggressive when they’re older, an age-based option might be the best. And look at the cost. Assess what the administrative fees with the investment costs are, because you want to make sure there’s more money for the education versus for fees and costs.
And what I’ve told my family is, the best present that you can give my children for birthdays and holidays is put some money into the 529 plan. And this is great, especially when they’re an infant, because how many rattles and burping cloths do you really need? The [Phonetic 00:16:18] 529 plan contributions are a much better alternative.
Doug: Jamie, let’s expand the scope of the discussion, because there are more ways to save for college funding than just the 529 plan. Let’s talk about the Roth IRA. There are some interesting things that you can do with a Roth.
Jamie: Yeah, so Roth IRAs are retirement savings vehicles and not specifically for education, but the nice feature that Roth IRAs have is you can use these monies for qualified education without any tax consequence, with some caveats.
One caveat is that you can only use the contributions that you’ve made into the plan, not any earnings. And this will avoid any penalties. So, to give you an example, to explain this a little further, if you put $25,000 into your Roth IRA and it’s now worth $35,000 you can withdraw that $25,000 tax-free for education, but not $35. Okay? Only the $25.
And another thing to be cognizant of is that the money in retirement plans don’t count against you for financial aid, but when you take that money out of that retirement plan, it is included in income and may count against you for financial aid purposes.
Doug: And, one of the other ideas that we wanted to float here is… Obviously if a family has adequate cash flow, the Roth IRA is a way to be able to save and have more flexibility, for instance, if the child doesn’t go to college. And, you have more investment flexibility with the Roth IRA versus the 529 plan. Certainly, you want to be thinking in terms of multiple sources of savings and income for when a child is in college. It’s not just about a pile of money as you go through a, you know, four years of an undergraduate program. It is about an income stream. That’s what really the child is going to need, because there is not only tuition, but there are living expenses along the way and that kind of thing.
So, again, the Roth IRA idea here that we’ve put forth is just an idea of getting some additional dollars saved that gives you more flexibility than a 529 plan. But there’s a couple of other ideas. And we had just mentioned, obviously, tapping into one’s savings, but you had some advice around just drawing out of a savings account, Jamie.
Jamie: So, when you use your savings account, make sure you save enough for your emergency fund. I like to tell clients you want to have at least six months to a year’s worth of cash in your savings account of expenses.
So, if you’re spending $100,000 a year, you want to keep at least $50,000 to $100,000 in cash in case there’s an emergency. And this may be a roof in the house, or car dies, and things of that nature, or if someone loses a job. You want to make sure that you’re not invading that emergency fund for education.
Doug: Well, Jamie, you’re in New York, I’m in California, and we are both in states where there has been a lot of investment in real estate, and in some circumstances, I have seen client balance sheets where they have a large percentage of their net worth in their home, and they don’t have that much liquid cash outside of the home
So, one of the things we talked about was a home equity line of credit and potentially using some of that for college education, but there are some dos and don’ts. Jamie?
Jamie: We don’t really recommend this for long-term cash needs. If you need to bridge some timing and need the cash now to put the tuition payment in and then reimburse from the 529 plan, then this is a good way to do it.
But the one nice thing about the HELOCs these days is, the interest rates relative to student loans are pretty low. And prior to 2018, you could deduct this interest on your tax return if you itemized your deductions.
Unfortunately, now with the new tax law change, that’s not available. The HELOC proceeds must be used for home improvements in order for it to be deductible. And, again, a lot of people are going to probably take the standard deductions due to some of the limitations on state income taxes and real estate taxes.
Doug: So, Jamie, a couple other things. I think you’ve had some experience with this, but just talk to us about that concept of student loans and financial aid. Sometimes those lines get blurred. What do you know about that?
Jamie: A lot of times when you fill out the financial aid forms, they determine this estimated family contribution, and this is the amount that you need to come up with to fund your children’s education costs.
A lot of times there are loans available to the students that you can utilize which are either subsidized or unsubsidized, and there’s also parent PLUS loans that are also available to use. One thing to make sure you remember is, these all have to be paid back at some point.
So, it’s not a scholarship or a grant that’s free and clear. You have to pay these loans back. And making sure you budget that into your cash flow is very important, especially if it’s a parent PLUS loan that may affect your credit if you and/or your child don’t pay.
Doug: And, what do you know about the terms… You mentioned interest rates on student loans and also the length of time that those loans are usually deployed with the duration once a child has graduated. How does that work?
Jamie: There’s been a lot of government program changes through the years. On this one I have to kind of say it depends on what the child’s making. So, there are programs available that, for a payment you just do 10 years over a term and then you have a 5% interest and then you pay that loan back over that time frame.
Now, because our students these days are taking on large amounts of debt, especially for graduate and professional degrees, they might have a payment that’s probably more than a mortgage for some people.
And what the government did was enact these income-based repayment plans and what they do is limit your payment to a certain percentage of your earnings, and so if you become a doctor and you’re a resident and your pay is pretty low, these income-based programs are very helpful. So that way you can still live…rent or buy a home and also pay your student loans at the same time.
Jamie: My first recommendation is to open up a 529 plan as soon as you get a Social Security number for your child and tell all your family to do the same or to start contributing to your 529 plan in making those gifts. It’s very important to start early.
Second thing, have a plan. Make sure you have the plan in place and discuss it with your children. If you say, “I’m going to contribute this amount and you’re responsible for the rest,” you have a plan, and that way there’s no surprises when the child goes to college.
And something I like to tell clients is to make sure that their student has skin in the game. It’s all well and good if their college is paid for, but if they don’t have that loaned of $2,000 to $5,000, let’s say, then they won’t be inclined to succeed as well, in my opinion.
So, if you give them some skin in the game, take out the loan, then they know, “Boy, I better repay this back and I’ve gotta do well. If I do well, I might get some scholarships and not have to take out these loans.” So, I think that’s very important.
And then, my last piece of advice is just make sure you don’t sacrifice your retirement savings for your child’s education costs. It’s very important, because once that money is spent on your child, you’re not going to get it back, and you’ve just lost all that compounding, and there’s a big, huge opportunity cost there.
Doug: Awesome. Great summary, Jamie.
Ladies and gentlemen, I always like to end the podcast with some action steps, so I’m going to add to Jamie’s takeaways. One of the things I would encourage you to do is to share this podcast with family members, with friends, with those who have children, to get this message out there about starting early to save for college education and as Jamie already mentioned, if you do have children, you’ve got to put together a plan specifically for college funding. That way, you can start to project out into the future a target number, have a goal. Once the child is in high school, starting to talk about the cost of college education.
There’s a lot of choices when it comes to college education, and you want your student to understand sometimes you gotta give things up in order to be able to achieve the goal, and obviously watch out for debt. And then, lastly, review your 529 plan options and then also consider the Roth IRA.
So, Jamie, great show. Thank you very much for contributing today, and it was a pleasure having you on the podcast.
Jamie: Thanks for having me here, Doug.
Doug: Ladies and gentlemen, thank you for listening to the Science of Economic Freedom. This is Doug Fabian. If you’d like to send me an email, my email address is [email protected], [email protected]. Thank you for listening.
Announcer: The Science of Economic Freedom is intended as an investor education resource. The views and opinions expressed on this program should not be construed as a recommendation to buy, sell, or hold any specific security. Consult your investment advisor and read any investment prospectus carefully before making any changes to your investment portfolio.
This program is sponsored by Mercer Advisors. Mercer Global Advisors, Inc. is registered with the Securities and Exchange Commission and delivers all investment-related services. Mercer Advisors, Inc. is the parent company of Mercer Global Advisors, Inc., and is not involved with investment services.