Five Unintentional Mistakes Parents May Make When Saving for their Kids’ College Education
Are you a parent who intends to send your kids to college? You probably already know that college tuitions continue to soar. In fact, a college education for a child can be a parent’s most expensive endeavor outside of retirement.
A recent study conducted for lender Sallie Mae says that parents are saving less for their kids’ college now than in past years. Parents are instead choosing to put money into “rainy day” savings, general savings, and retirement.
The study also said that 80 percent of parents agreed that college is an important investment—and they recognized the increased value of their kids having a college degree in today’s world.
So, what’s the best way to prevent becoming overwhelmed by the need to save for your kids’ college while simultaneously saving for retirement and other life events? Make sure you avoid the biggest savings mistakes that so many parents make.
Read on for the five most common savings mistakes you may want to avoid.
Potential Savings Mistake #1: Using college-specific savings plans
There are a lot of college-specific savings plans, the most popular being a ‘529’ plan. These are savings plans designed to be used only for college funding purposes and give the student and parent tax benefits by agreeing to the plan terms. Most college-specific plans are invested in mutual funds and, as with typical investments of these types, the parent can choose to have a high-risk or low-risk plan.
From a savings perspective, the problem lies within the “what-if” and “how” questions that parents should be considering:
- What happens if you set up a 10- or 18-year savings plan and the market doesn’t perform as well as expected—or worse, what if the market tanks during that period?
- What happens to the contributions to a college savings plan if a parent becomes disabled or dies prematurely?
- How do the fees charged for the savings plan affect the amount available when college starts?
- What happens to your money if your child doesn’t go to college for some unexpected reason?
- What happens to your money if your child gets a full scholarship and doesn’t have to pay for college?
- How much will college cost in the future? Will your savings plan be sufficient at that time?
- How will a college-specific savings plan affect your own financial future?
These plans typically don’t come with a cost recovery strategy. All parents should be asking how they may be able to get their money back after paying for college. Also, if a family can avoid paying for college, retaining this capital would significantly complement their retirement.
Before choosing a savings plan, it’s important for parents to think about and discuss all available resources to pay for their kids’ college education—not just college-specific plans.
A financial representative skilled in college savings and overall wealth building can typically help you find a less expensive and better option than college-specific savings plans.
Potential Savings Mistake #2: Putting too much money away into pre-tax retirement accounts
Are you pumping as much money as you can into a tax-deferred retirement account?
It’s easy to assume that the more money you put into tax-deferred accounts results in greater wealth later. Here are some of the reasons that usually lead people to do this:
- You could be saving on your current taxes
- Your employer matches some of your contribution
- You pay no taxes on the annual growth
- You expect to be in a lower tax bracket in retirement
- You find that it seems quite easy to save for retirement this way
If you evaluate your current tax bracket, along with your other potential assets, you will likely find that contributing any more than seven percent of your gross income may put you in a position to be overpaying in taxes during retirement.
You may be in a higher tax bracket when you retire, not lower. It’s true that an employer match does add value to a savings plan such as a 401k, which is why contributing no more than the maximum employer match (usually around seven percent) may be in your best interest.
Want to save more for retirement? Good! You might want to consider an after-tax strategy for any additional contributions to retirement savings so that you may have more options and flexibility during your retirement. That’s important, as over time, financial options and tax brackets may change.
The bottom line is: be proactive with your retirement savings. Position your cash flow in a manner that enables you to maneuver and take advantage of changing economic conditions—instead of reacting later.
When it comes to saving for your kids’ college education, always be mindful that having the majority of your assets in a pre-tax investment—like a 401k—can resemble having your money tied up in a straitjacket instead of being maneuverable when you need it to be.
Potential Savings Mistake #3: Having a 15-year mortgage
Most of us have been persuaded to believe that the least expensive way to buy a house in order of preference would be with cash, a 15-year mortgage, or a 30-year mortgage.
Now, think about the biggest benefit for banks and why they might want to promote the options in the order listed above. It’s quite simple: banks want to have your money in their hands as quickly as possible. As a result, they may try and sell you on the idea of buying with cash or with a 15-year mortgage.
Saving on interest is the big carrot that many banks dangle in front of consumers to sell us on these two options. However, what many people don’t consider, and what many banks don’t tell us, is that there may be lost opportunities if you go with the cash or 15-year options.
Imagine if instead of being completely in the bank’s hands, more of your money was in your own control. In this scenario, you get to have a savings plan strategy that could possibly earn interest on that money.
Your money should work for you.
Since most residential mortgage interest is tax deductible, a longer-term loan like a 30-year mortgage lets you have lower monthly payments, resulting in higher cash flow.
And with that higher cash flow, you may have extra funds available to help pay for your kids’ college education.
Potential Savings Mistake #4: Failing to have financial protection from an unexpected life event
People want guarantees with their investments. But the only real guarantee we can count on is that unexpected life events may happen, such as a long-term disability, a lawsuit, or premature death. These may have a serious financial impact.
Protection and defense against unexpected events is a fundamental principle necessary for a sound savings strategy. We may no longer need stone castles and moats to protect our personal assets, but we all need to safeguard our financial plans in the areas of liability, disability and life insurance.
Everyone should have a well-coordinated financial plan in place that includes insurance. While many treat insurance as a necessary evil or even a poor investment, it is an extremely important part of the wealth building strategy.
If you haven’t already considered how to safeguard your plans for college savings, it’s time to give your financial representative a call so you can make the best possible choices when planning for your kids’ college education.
Potential Savings Mistake #5: Not saving 15 percent of your gross income
Not everyone can save a full 15 percent—but you should have this as your goal. With that goal in mind, you can then try to increase your savings each year to reach that level.
Many of us forget that money changes in value and will erode over time. Here are the 10 major causes of “money value erosion”:
- Technological change
- Planned obsolescence
- Financial expenses
- Lost opportunity costs
- Interest rate declines
- Stock market declines
- Loans and interest changes
So, why save 15 percent?
That number comes from attacking 5 of these causes of money losing its value:
- 3% to help overcome the cost of inflation;
- 3% to help address tax increases;
- 3% to help handle the costs of technological change;
- 3% for the costs of planned obsolescence
- 3% to accommodate unforeseen factors.
The 15 percent rule assures a successful retirement in most cases. Any less than that, plans may weaken, lifestyle value is lowered or debt increases. With a successful retirement plan under your belt, you may open up financial possibilities and reduce the stress of saving for your kids’ college education.
Scott Karl is a licensed financial representative in Fresno, CA. Since 1994, he’s provided a variety of financial products for his clients, including long-term disability income, health plans, mutual funds, life and annuities, qualified plans, retirement plans, college education plans and legal services.