Early retirement and the kid’s college fund

This is another perennial (and heated) topic on discussion boards like Early-Retirement.org and Bogleheads.org. I’ll try to distill years of debate (and thousands of posts) into the most popular suggestions.

Before we get into the mechanics of saving & investing the college fund, let’s figure out why you’d want to have a college fund in the first place.

Disclosure: Our opinions on paying for college are biased by our own college experiences. Nearly 30 years later I’m still ambivalent about graduating from a service academy, which back then was billed as “A six-figure education, taken out of your hide a nickel at a time.”  (Today we call that “Having skin in the game”.)  Despite hours of rigorous financial analysis, your opinion will be affected by how you felt about your parents’ support (or lack thereof) for your own higher education. Try to get over it work through those feelings before you make the same decisions for your children.

Get your priorities straight:

First, don’t sacrifice your retirement savings for your kid’s college fund. If they were of your age and experience, they’d feel the same way. Only you can take responsibility for your retirement finances, and you do not want to be a burden on your new college graduate. They don’t want to support you after your working years any more than you enjoyed supporting them after their schooling years. Get your own financial house in order before trying to take care of your kid’s education.

Second, you have no obligation to put your kids through college. That’s their problem. There are plenty of ways to pay for college, and plenty of affordable colleges that will challenge their freshmen to their full potential. If college is really their priority then they will get it done.  When they show the commitment then you can reciprocate– if you want to.

Your money is not what turns your kid into a college graduate. They have to supply their own internal motivation. If you don’t think they’re ready for college then tell them so– and dare them to rise to the challenge. (Proving your parents wrong is one of the most powerful motivators known to the human race.) They’ll find their own path and earn your respect.

Third, if you’ve chosen to retire early (as soon as you reach your own financial independence) then are you obligated to keep working for your kid’s college fund? Doesn’t that seem selfish?

Again, if your kids were in your shoes, they’d urge you to retire early. They’d rather have your attention and your time in their lives, not your money. (Stay with me here. They won’t share this with you until they have kids of their own.) You can have a far greater effect on your child’s success by retiring early to be with them than by slaving saving $275K to support their four years at an élite private college. Feel free to work for a paycheck if you enjoy it, but don’t sacrifice your health (both mental and physical) just to afford the tuition to “a good school”. Your kid won’t understand (let alone care about) your “sacrifice”. Even worse, you’ll feel resentment if they don’t carry a 4.00 GPA with “your” college money.

With those priorities in mind, it turns out that helping your kids pay for college is in your own best self-interests as well as theirs. Stacks of even the most pessimistic economic studies have shown that college graduates have higher lifetime earnings than high-school graduates.  Although college is (at least) four years of lost earnings potential, the payback more than justifies the investment in their lifetime earnings.  Just as importantly, the college experience also forces your young adult to start thinking like one.  They’ll soon develop the life skills needed for independent living. It doesn’t take much for your college student to chafe under the social stigma of living at home with their parents, and soon they’ll be focused on getting their own place. Even if their degree doesn’t generate an immediate job offer, they’ll still have their motivation to move out. It’ll happen a lot earlier for your college graduate than for a high-school alum working shifts at a fast-food franchise. The sooner they start their own lives, the quicker you can have yours back.

That’s good news, because we good parents want to help our children find success while we vicariously share their happiness. Even if we can’t stand those darn kids, then helping them through college at least gets them out of our hair that much more quickly. So when you decide what to save in the college fund, do it for the reasons that make you feel good as well as for your progeny’s financial boost.

How should you save your college fund? Today’s financial engineering offers a number of options.

First, check your GI Bill benefits.  Depending on your service dates you may qualify to transfer some or all of your benefits to your kids.

Second, consider a 529 plan.  You’ll receive federal and state tax benefits that will put more money to work for paying college tuition. Although money in a 529 plan must be used for educational expenses, the rules are very flexible. Benefits can be used at any time and transferred if desired. 529 plans have higher investment costs that are usually less expensive than the benefits. If you’re concerned about “locking up” too much money in a 529 plan (“What if my kid gets a full scholarship or goes to a service academy?”) then limit this part of the fund to a year or two of expenses at a public college. You’re trying to plan 10-20 years into the future, and plans change.

Third, look at savings bonds for education.  This method of savings has lost much of its attraction over the last 10 years due to the economy, Treasury restrictions, and the rise of the 529 plan. However, it’s still possible to purchase a limited amount of I bonds,  both in paper and electronically from the U.S. Treasury. If they meet all the requirements of the “education savings bonds” program, then the earnings are tax-free for tuition expenses.  More importantly, if these funds aren’t needed for college then they can be used for other (taxable) purposes– retirement savings or a really nice graduation present. This a great tax-free way to save another couple of years’ expenses at a public college.

Fourth, consider a trust. Back before 529 plans, Uniform Trust to Minors (UTMA) or Uniform Gift to Minors (UGMA) accounts used to be the only tax-deferred way to save for college. These have fewer restrictions than a 529 and the earnings are taxed at the child’s rate instead of the parent’s. Although the money can be used for other purposes as well as for college, unfortunately this asset is considered to be the property of the minor– not the trustee. The biggest drawback to a UTMA/UGMA is that your kid could decide to blow it on a really nice car. You have to know your child, but a 529 plan probably aligns your tax situation better with your educational goals.

Finally, save money in taxable accounts. These provide the greatest flexibility with lower expense ratios. Parents can gift appreciated shares of stocks or mutual funds to their children, who would sell them at a lower capital gains tax rate and use the proceeds to pay their college expenses.

All right, I’ll mention this option before everyone comments on it:  consider joining the military. No, I’m not advocating sending your kid to recruit training or a service academy.* Instead I’m suggesting that they investigate ROTC programs.  If they’re even mildly curious about the military, let alone interested in it, then ROTC is a great way to “try before you buy”. The first year has no obligation, and (unlike a service academy) the cadet/midshipman can drop out during that time yet stay at the same college in the same dorm with the same plans for their major and their graduation (and their friends).  (They just have to start paying their own tuition).  ROTC has intangible benefits, too. It imposes a low-stress social structure on teenagers who may have difficulty focusing on their priorities or managing their time. It offers instant friendship and mutual-support opportunities with other ROTC students. It supplies a number of adult mentors and role models, both officers and enlisted, who are also taking college classes. Finally, it includes a “free” exercise program and even puts a little cash into their student’s pockets. At the end of the first year the rising sophomore will spend part of their summer learning about the “real” military, and then before starting their sophomore year they can decide whether to continue for the military’s service obligation.

How much do you need to save for college? That’s a highly individual analysis for another post. However, you should start saving something as soon as you get a Social Security number for your blessed little bundle of joy. For every $100 you save toward retirement, consider saving $10 for their college fund. Put 80%-90% of their first five years of birthday/holiday gifts into the college fund, too. No matter what type of savings program you use, the best way to save it is to maximize the time it has for compounding.

* Enlisting or attending a service academy will work too. This is great for teens who are seeking a different sort of challenge, or who aren’t necessarily ready to tackle college on their own. I’ve seen it many times during my military career– after a year or two of enlisted experience or a service academy, your high-school slacker will be highly motivated to finish their college degree.
Another disclaimer: I attended a service academy for the irresistible challenge my own personal reasons. My parents never shared their finances with me and I never thought to ask. A service academy turned out to be exactly what I needed at that point in my life, and a college fund would have just been wasted on partying.

Related articles:
Retiring early– with kids?
Raising an ER-smart kid
Raising a money-smart kid

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WHAT I DO: I help you reach financial independence. For free. I retired in 2002 after 20 years in the Navy's submarine force. I wrote "The Military Guide to Financial Independence and Retirement" to share the stories of over 50 other financially independent servicemembers, veterans, and families. All of my writing revenue is donated to military-friendly charities.

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