I'm a huge fan of developing an “order of operations” for different financial activities. You may remember last year I invented FIBS as a order of operations for saving for retirement. FIBS stands for 401k, IRA, Brokerage, Social Security. It's just an easy way to remember the order you should do things.
But, what about a closer goal – such as saving for your kid's college expenses. Well, I created a new order of operations for you to remember: YES! Yes, it's that simple, but I'm actually talking about Y.E.S.
Okay, enough with the play on words, here's the order of operations for saving for kid's college:
(Y) – You
(E) – Education Savings Accounts
(S) – Savings
Let's break it down a little bit further and explain what I mean.
Step 1 – You
Saving for your kid's college starts with you. You have to get your own financial life in order before you can help your kids. When you fly on a plane, the flight attendants make a huge point about making sure you put your own mask on first in an emergency. The reason? You simply can't help others if you're passed out. The same is true with your finances.
I've long said you can't get a loan for retirement, but you can get a loan for school. Before you can save for your children's education, you need to take care of your expenses. You need to pay off your debt, achieve your short-term goals (such as buying a house), and make sure that you're free of student loans. There's no reason to save for someone else's education if you haven't paid off your own education yet!
So, the bottom line is before you can save for your kid's college, you need to take care of yourself.
Step 2 – Education Savings Accounts
Once you've conquered step 1, you can look at education savings account options for your children's education. I really like 529 Plans to save for your kid's college, but you can also use Coverdell Education Savings accounts, or even basic UTMA (Uniform Transfers to Minors Act) accounts.
The reasons I like 529 Plans the best is:
- The tax advantaged nature of the account (which can vary by state)
- No income restrictions
- High contribution limits
While every situation is different, you should find a education savings account that works for you and your child.
Step 3 – Savings
Finally, after you start funding an education savings account, you should just focus on savings in general. By this, I mean you should dedicate a specific amount each year to the education savings account, and then save in a general account for yourself beyond that.
For example, maybe you want to contribute $5,000 per year to your child's education savings account. After that, just put the rest in savings. The reason? By the time your child goes to college, you'll have a nice nest egg in the education savings account, and you'll also have a nice amount in your own savings to pay for things beyond education.
If you plan on helping your student (like most parents do), you have to remember that there are more costs than just education. Education savings accounts (like 529 plans) are great, but the withdrawals are limited to education expenses if you want the tax benefits. But, what about travel costs for your student? Or buying a car? Or helping with rent? Or paying for a cell phone? Or getting them a laptop?
All of these expenses can't really come from the education savings account. That's why it makes a lot of sense to keep a nice bit of savings aside for your child's other expenses that can't be covered by education savings accounts.
A Recap of YES
So, there you have it – the order of operations for saving for your child's college expenses is Y.E.S.
Y – You: You have to take care of yourself first
E – Education Savings Account: You an appropriate education savings account
S – Savings: Make sure you save a little beyond the education savings account for other expenses
What are your thoughts on Y.E.S.? Do you think it helps with your thought process for saving for your kid's college?