Hello everybody, it's Sam from Financial Samurai and in this episode I want to talk about one of my favorite favorite subjects and that's paying for our children's college education through a 529 plan. Now the 529 plan is an excellent idea because you contribute after-tax money and it gets to compound tax-free and when you withdraw the money for qualified educational expenses you don't have to pay any tax or penalty or anything whatsoever.

So when you're saving and investing your money you might as well take advantage of every single plan out there that reduces your potential tax liability. 401k and IRA and Roth IRA for your retirement, 529 plan for your kids college education. Sounds simple enough. And one of the greatest things to come out of the coronavirus induced market meltdown is our ability to contribute more to our retirement accounts and to our 529 plans.

So I personally was able to contribute an extra $30,000 in March 2020 when the market was melting down because I figured you know what it's gonna be for the next 18 years for my daughter so I have no problems investing with that real time frame. Whereas investing my hard-earned precious cash into a taxable account that was a much much dicier proposition and I still went through I still invested a decent chunk of change but I'm out I'm out at $2,850, $2,900, $2,930 on the S&P 500.

I couldn't hold on to that money that I inputted into the market in March because I'm just afraid of a relapse. But with a 529 plan it's like 18 years come on 18 years I think things will be okay. But what I realized is that I ended up super funding my daughter's 529 plan.

I didn't plan to do that before the pandemic hit. I was like okay I'm gonna contribute $15,000 a year and then just keep it that way because we have just gone through a 10-year bull market and things were dicey. So if you look at all my previous posts, a lot of my previous podcasts, I'm just kind of a more conservative guy when it comes to the stock market and I have been for the past couple years.

Now once the markets started melting down I was like alright let's start contributing so I super funded it with $75,000 and that's when I realized hmm maybe I contributed too much to my daughter's 529 plan because my son is three times older than my daughter but he only has about 90% more.

So let's talk about what is the appropriate amount to contribute to your 529 plan by age. And to get to this answer we need to figure out what the endgame is. What is the cost of college going to be like in the future? Well right now for the average tuition and fees for 2020, public in-state is about $10,116.

Public out-of-state is about $22,600 and for private schools the cost is about $37,000. That's a lot of money folks and the one thing we should all recognize is that the value of a college education has taken a step down. It has devalued post the pandemic, post the lockdowns because everything is being done online right now you know through Zoom, WebEx or whatever and everything online is already free.

So if we're doing everything online with college education and everything online is already free what the heck is a parent supposed to do? Still spend the same amount of money for that college degree? No I don't think so because most of college I would say 60 to 70 to 80 percent of college okay 80% of college is about the experience.

It's about getting to know great connections and friends and going out to party and doing stupid things and learning from your mistakes. It's that whole experience that you're going to college for. The educational component of college is you know it's probably like 20%. You know you're going there to learn, listen, try to build on your degree so maybe you can get a master's maybe I don't know or you're just trying to learn on the things that you want to become an expert in so that you can get a better job in a relevant field in the future.

Let's be frank I think most of us do not remember more than 10% of what we learned in college. At least I don't and it also doesn't make sense to still spend four or five years getting your college degree because hello the internet, technology, you don't have to go into the Dewey Decimal System and you know research books and check them out and spend tens of hours writing a paper.

You can do things at least twice as fast now versus before the internet. So think about the way things are. The price of college should be declining but it's probably not going to be because of you know old inertia and greed and so forth and the duration it takes to get a college degree.

Four to five years it's probably not going to decline either because it is against what colleges want and they so long as we demand going to college they're going to dictate terms. So I've gone ahead and created a recommended five to nine plan amounts by age and it's in a handy-dandy chart.

Four columns. First column is your age. The second column is called low or alpha. The third column is called medium or Bravo and the fourth column is called high or coca. Now these columns represent how much you should save by age depending on your circumstances and beliefs. For the low column or alpha column, alpha sounds better doesn't it?

Someone was saying oh I'm only in the low column I feel bad. Well that's just not the point. The point is if you're on any of the columns for sure that's pretty good because it hopefully is jiving with your beliefs about college education and your children. So let's look at the age 18 amounts for each column.

So at age 18 the low alpha column 95,000 to 100,000. Your goal is to accumulate about $100,000 by the time your son or daughter turns 18. In the medium column, the Bravo column, you should try to accumulate about $500,000 and in the high-end column or the coca column a million dollars.

A million dollars sounds crazy. You're creating five to nine plan millionaires. We talked about this before but let's be frank there are parents out there who are willing to spend $800,000 to over a million dollars for their child's education. Personally I would rather just maybe I don't know but I think I would rather just set up a trust and create that fund for my child and have him or her go to public school and save a lot of money.

And if I was a child and my parents said we will give you a million dollars if you go to public school for grade school and go to community college or a public school for college and I would say hell yeah give me the money give me the million dollars and I can start a business start a family do whatever I want awesome but you know everybody has different opinions and that's totally fine.

So let's talk about the low column the alpha column. It assumes that you just contribute $5,000 per year with 0% growth to account for several bear markets during the initial 18 years. The goal is to have saved right $100,000 by 18 and I think that should be decent. Here are some bullet points for those who might want to follow the low column.

Parents who have older children already you know they're 10 plus and you know you just can't save as much. Look I don't want to have you feel bad because you don't have the right amount based on what I'm recommending. I'm just saying like if you have a 15 year old and you didn't continuously save since he or she was zero well you're gonna be kind of behind.

So here at the low column you have older children. To parents who don't strongly believe in the value of a college education you believe that the college education is declining in value might be free one day and you won't have to pay such a crazy crazy amount. Your child will go to a public university or community college to your college or potentially no college.

Most of Americans don't have a college education and this is important to realize for those who have just been thinking about college all their lives you're not the majority. Fourth point maybe your child is a genius or a talented athlete and will get tuition subsidies from universities. The next point maybe you have a family business and the child likes your family business and you can just easily hire him or her into the family business.

And then finally you as parents may have many children and you simply cannot fully fund all their five to nine plans but you want to fund them enough so that they don't graduate with massive massive amounts of debt and feel bitter at life. Let's move on to the next column the medium column or the Bravo column.

The Bravo column assumes a 15,000 annual contribution every year until 18 with a 6.2% compound annual return. I came up with 15,000 because that is the gift tax exemption amount per person so hopefully one of you guys can give 15,000 every year. And how did I get to 6.2%?

Well it's kind of back of the envelope calculation because I want the medium column to get to about 500,000 for college by the time your son or daughter turns 18. So to get to $500,000 with a $15,000 annual contribution you've got to earn 6.2% a year and that's reasonable.

Think about how much stocks have returned since 1926 it's about 8 to 10 percent. Think about how much bonds returned since then it's about 4 to 6 percent and the returns are going to get smaller and smaller as you get to 18 hopefully because you want to spend that money and not lose that money.

So 6.2% I think it's reasonable. It's up to you to make the assumptions but I think it's reasonable. So who should follow the Bravo column? Well parents who have a newborn or children under three seems decent. You've got 18 years, 15 to 18 years to save and invest. Parents who only plan to have one or two children so not that many children.

Parents who believe a college education is still valuable although you know you might realize it's not as valuable as it once was. Your child is of average intelligence and average athletic ability therefore your child is probably not going to get any grants or scholarships. How about parents who want to hedge against a continued rapid increase in college tuition?

College tuition has been rising by about say 4 to 5 percent a year. Some higher, some lower but around 4 to 5 percent. You would think that the majority of schools would freeze their tuition for the 2021 school year but so far I've only heard my alma mater the College of William & Mary freeze their tuition.

Good for them and I hope other colleges and universities do the same especially those with massive massive endowments. Next, parents also have a family business. Why not hire your kid especially if he or she likes the family business? And finally parents who tend to be more financially conservative. In general it's a good idea to end up with a little bit too much money rather than a little bit too little but either way a little bit a little bit on each side is not bad so it's better to have too much money rather than too little money.

Moving on to the final column, the high column, the COCA column. This assumes a 30,000 annual contribution every year until 18 with a 7% compound annual return. So you get a double whammy here. Two people contributing $15,000 and a higher rate of return. 7% it feels a little bit aggressive nowadays especially after a long bull market and especially we saw a loss decade from the year 2000 to 2010 but these are my assumptions so that parents can get to 1 million dollars by the time the child is 18.

So again a little bit back of the envelope to get to that 7% but a million dollars is that target amount and it sounds crazy but you know from reading my previous posts and perhaps listening to my previous podcast that one can easily spend $800,000 on grade school education from kindergarten through 12th grade and then for private school and everything and then you add on inflation and rising costs and the opportunity costs of not investing your funds in profitable investments and yeah $1 million doesn't sound too unreasonable and you can't blame parents for wanting to give their kids the best if they can afford it or if they want to do it but if you want to do it you got to try to get to a million dollars so who should follow the high column the coca column well parents who have a newborn or child who has yet to be born because you can open up a 529 account under your name and then transfer it to your child's name I know one reader told me he opened up a 529 plan account in 2008 12 years ago and they don't have children yet and I think they probably want to have children a little bit sooner than that but you know good for him for planning ahead and I think once the kid is born the kid will have a pretty good 529 plan okay second parents who plan on only having one or two children a child is of below average intelligence and athletic ability so below it's not just average but below it's kind of ironic but look that's just the way it is it's a very competitive world out there getting scholarships is tough and you know not everybody is going to be average or above average please don't take offense the child insists on going to the most expensive private school whether that's grade school and college I don't know some some kids I hear they just don't care they want to go to the most expensive school and it doesn't matter if it's not their money or not parents who are very wealthy and are willing to make their children five to nine plan millionaires and are okay with with taking that risk because I think a lot of parents worry what if what if we give our children everything best private schools huge five to nine plan you know we're driving around in nice cars we have a huge house are they gonna are they gonna want to work hard themselves and identify and build their own identity I think that's it's hard who knows next parents who believe college tuition will inflate much faster than three to five percent a year it's possible it's been doing that for decades now and then finally grandparents who have enough money to superfund their grandchildren's five to nine plans to help reduce their estate super funding just in case you don't know is the ability to contribute five years worth of $15,000 a year in the first year so that is $75,000 per person and once you do that you can contribute for the next five years so if you've got a lot of cash or your grandparents want to reduce their taxable estate because it's above the taxable amount in 2020 that's eleven point five eight million per person you can do that you can superfund you you might be able to even fully fund the five to nine plan and go to the max but of course check with your lawyer and check with your estate planner and so forth I do want to reiterate that there is no precise and right amount you shouldn't contribute by age the goals are $100,000 $500,000 and 1 million dollars by the age of 18 or whenever your child wants to go to college and this is really dependent on your income your beliefs where you live and the future not everybody knows the future I don't but we can have some guesses all columns are fine if the amounts are aligned with your goals and beliefs if you're behind contribute more or convince a grandparent or loved one to contribute more if you're ahead you can throttle your contributions and use your money for other purposes it would be irrational if you save based on the low column but of a child who is one year old and you want him to go to the most expensive private university in 18 years without any grants conversely it would be irrational to follow the high column if your child is already 14 years old is brilliant and will likely get a free ride to any school she chooses whichever column you do choose to follow make sure the numbers align with your current financial situation your child's intelligence and work ethic and your beliefs about higher education as for my family we're probably going to follow the medium column the Bravo column and try to shoot for 500,000 per child because my kids are only three years old and almost five months old now so that's 15 to 18 years to go maybe longer if they decide to take a gap year who knows I've done the math and $500,000 looks like the realistic quote worst-case scenario in terms of cost and I'm generally a conservative person so I would love to build enough money in the account that it can cover 100% of the cost if necessary now I don't know whether I want to cover the entire tuition room and board expenses for my children it's always good to have some skim in the game you know working at McDonald's in high school really made me appreciate the value of the dollar because making $4 an hour while flipping burgers and cracking eggs really really kind of stung so I really appreciated the value of the dollar and it made me work harder so this is something you got to figure out for yourself I have no idea exactly how my children will turn out in terms of work ethic work ethic I really think is the number one thing that'll help people get farther in life and I hope to instill that into my children by demonstrating you know dad waking up at 4 a.m.

5 a.m. and working or pulling the weeds or whatever but there's just no guarantee ideally I think it's good to save just the right amount in each five to nine plan but if you end up saving too much you can always just reassign the beneficiary to your grandchildren or someone else thanks so much everyone and if you like this episode I'd love a positive review and share with your friends gosh it took a long time to create that chart and to think about this but this is important we got to think about these things as parents and I hope every single one of you have brilliant children who won't need that five to nine plan at all oh there actually might be a problem you save too much in your five to nine plan and you didn't live as good of a life as you could have but let's just talk about that in a different episode thanks so