What Comes First? A Step-By-Step Guide to Financial Independence. Step 5: Set Up College Funds
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Welcome to the fourth installment of Independent Beginning’s Step-By-Step Guide to Financial Independence inspired by Dave Ramsey’s “Baby Steps”. Yesterday, you learned about Steps 3 & 4: Complete Your Emergency Fund & Set Up a Retirement Account. Today, you will learn about Step 5: Set Up College Funds.
Step 5: Set Up College Funds
By step 5, you will have completely set up your emergency fund, paid off all your high-interest debt, and started a retirement fund to which you are regularly contributing. At this point, it is time to set up college funds for your children. If you have children now or plan on having children someday, this is an important step to take.
Why should you save for your children’s college expenses? Although some people are fundamentally against saving for their children’s college expenses, I personally believe it to be an important part of my financial future. There are several reasons why I want to help with my future kids’ future college expenses. The first reason is that I think it will help to show my kids the value I place upon education and the expectation I have for them to go to college. Knowing that I have saved up a sum of money exclusively for their college expenses will help them to realize that I am serious when I tell them that I would like for them to pursue higher education. The second reason that I want to help out my kids with college expenses is because I do not want them to have to go into large amounts of debt to pay for college. I was fortunate enough to receive a lot of help with my own college expenses and I know that I have it a lot easier now because of it. The final reason why I want to help my kids out with their college expenses is because I do not want them to be forced to work their freshman year. I think a year without work is a nice way to help kids transition into college life and focus on their studies. I do not think that having a job freshman year is wrong, but I do think that it is nice to give kids the option not to work for that first year.
How much should you save for your children’s college expenses? The answer to this question will be different for each family. How much aide do you want to give to your kids? Do you want to pay for their first year of college? Do you want to pay for just tuition for all four years? Do you want to pay for their entire college careers? Look at the cost of colleges in your state. Then, adjust for inflation. College expenses actually rise higher than inflation. They rise about 7-8% per year. Determine how much those colleges would cost when your children enter them. Then, decide how much of that cost you want to cover. With that goal in mind, you can then determine how much you need to save per year to reach your goal.
Where should you invest your college fund? As I mentioned previously, college expenses rise about 7-8% per year. Because of this, you need to place your college fund somewhere that will equal or beat those returns. Probably the most highly recommended location for your college fund is a state 529 plan. 529 plans are tax advantaged and can be transferred to different beneficiaries if the original one does not need the money. You can choose any state’s plan. For help choosing a plan, see my article “How to Choose a 529 Plan for College Savings“. Another highly recommended location is an Education Savings Account. These accounts have more restrictions and only allow you to invest a certain amount per year. However, they are good options for college savings.
With your college funds in place, you are now ready to move on to Step 6! Tune in on Monday to see what it is!
Articles so far in the series:
- Step 1: Set Up an Emergency Fund
- Step 2: Pay Off Your High Interest Debts
- Steps 3 & 4: Complete Your Emergency Fund & Set Up a Retirement Fund
- Step 5: Set Up College Funds
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