If you are one of those who was lucky enough to not have student loans, you likely know someone else who had them or has them. It’s also almost impossible to avoid the near-daily reminders of how big of an issue student loan debt has become.
It’s natural to want to help your children – or future children – avoid graduating with a large amount of student loan debt.
For some that may mean delaying having children until a later age. But more and more millennials have children or plan on having them in the near-future. Many are thinking about what the best way to help their kids avoid student loan debt.
Anyone who has looked into this for even a short amount of time likely has come across 529 plans. If you aren’t familiar with 529 plans, they are used to save money for future education expenses. Withdrawals are tax free when used for qualified education expenses (i.e. tuition, textbooks on the required list for a class, etc.). Contributions are not tax deductible, so the benefit is the fact that the gains on those contributions are not taxed when you withdraw funds for qualified education costs.
We all know the cost of college has only increased in recent years. Saving for your children’s college education seems like a no-brainer, if not a necessary and responsible thing to do. After all, you don’t want them burdened with student loan debt, right?
But before you contribute to a 529 plan or continue to contribute to one, please hear me out. I have a controversial viewpoint that in a number of cases, if not most, you should not contribute to a 529 plan, nor should you save for your children’s college expenses.
You may be thinking do you not care about your children being drowned in student loan debt? And if you don’t know me, you may think I didn’t have student loan debt and therefore don’t understand the impact it has on your financial life and mental health.
But I did have student loan debt. A lot of it.
As I discuss in my book Student Loan Solution, my wife and I finished undergrad with $100k in student loan debt. We both had plans of going to grad school (only one of us ended up going), which would mean even more debt.
So I can certainly relate to those who have struggled with student loan debt. Virtually all our financial decisions since we got married nearly eight years ago were impacted by the fact we have student loans.
And even with that history of personally dealing with student loan debt, I still think people should take a pause and seriously think about whether it makes sense to contribute to a 529 plan to help pay for their children’s education.
Why You Should Rethink Contributing to a 529 Plan
To be clear, I have nothing against 529 plans. I think they can be useful tools for certain people. At the same time I think it should be low on the priority list for where your money should be going.
Most people are not in a financial spot where it makes sense to take advantage of a 529 plan.
Building a solid emergency fund, getting out of debt, and saving for retirement should all be a priority over saving for your children’s college education. I’ll touch on this more in a bit, but prospective college students have a ton of options for making college more affordable, and there will always be an option for them to take out student loans. There are no loans that can fund your retirement, though, and most people are not saving enough.
Here’s everything you should prioritize over saving for your children’s college education:
- Emergency Fund
There is nothing more important than an emergency fund. There are a wide variety of benefits from avoiding going into (additional) credit card debt, to dealing with a major house repair, or weathering a job layoff. You need an emergency fund. Here’s how you can build one $100 at a time.
- Credit Card Debt
If you have credit card debt, you need to pay it off before you start throwing money into a 529 plan. Even if you refinance your credit card debt the interest rate will still be relatively high. It may take a while, but paying off your credit card debt will be well worth it. You will free up cash flow to put towards other financial goals.
- Your Student Loans
It’s taking student loan borrowers longer to pay down their debt. Many millennials will have children before they pay off their own student loans. If you are considering putting money in a 529 account before you completely pay off your loans, I think you should reconsider. You’d be doing yourself a disservice by not focusing on your own student loans first.
- Health Savings Account
If you look at the statistics, High Deductible Health Plans (HDHPs) are becoming increasingly popular each passing year. The problem with HDHPs is that they can come with deductibles and out of pocket maximums that are crazy high. A deductible around $6,000 isn’t unheard of and you could argue is relatively common.The benefit of HDHPs is they come with Health Savings Accounts. Individuals can contribute a few thousand dollars, and families more than six thousand dollars, pre-tax to their HSA. This will help you build a medical emergency fund for any short-term medical costs, but HSAs come with additional benefits such as the fact that you can invest in mutual funds once you hit a certain savings threshold (typically $1k to $2k). You can withdraw funds tax-free as long as they are used for qualified medical expenses.
Health care costs are rising faster than the rest of the economy, and with new medical breakthroughs that will inevitably prolong the possibility of living into your 80s and beyond, you will need money set aside to get the best care later in life. That’s one reason I think it’s an absolute must to take advantage of an HSA by contributing to the max before contributing to a 529 plan.
- Retirement Savings
You knew this was coming, but retirement savings need to be prioritized over saving for your children’s college education. Your child has options for funding college; the only option for you to fund your retirement is by working and setting aside funds. The more you can contribute to tax-advantaged retirement accounts such as a 401(k), 403(b), or IRA, the better, as most are not saving enough for retirement.
As satisfying as it may be to tell your kid that you set aside thousands of dollars for their college education, it’s more important to focus on your financial life. That’s not easy advice to stomach, and your children may not understand at the time, but saving for your children’s college education needs to take a backseat to some of the things I listed out.
Obviously I shared a big list of financial priorities, and we didn’t even talk about things like basic living expenses, saving for a home, travel, insurance, or other things that eat up our paycheck. It can be overwhelming to think about all the different demands on your income, but that’s why I think it’s so important to take a step back and consider whether contributing to a 529 plan makes sense for your finances.
Alternatives to Contributing to a 529 Plan
The fact you are reading this means you care about your children’s financial future and clearly want to do the right things to help them be in the best financial spot possible when they finish college. The good news is that there has been a big increase in the quantity – and more importantly, the quality – of content focused on helping parents and high school students make smart financial decisions when it comes to college. There are even consultants today who are entirely focused on working directly with parents and students to set up students for financial success, which means a high quality education for the minimum amount of loans.
While you ultimately need to spend the time and dig into these topics yourself – like I said, there are books, blogs, and consultants solely focused on this topic – I can give you a quick run-down on the things that are typically focused on in the area of minimizing student loan debt:
- Scholarships
Approximately fifteen years ago when I was prepping to head off to college there was some mention of scholarships, but there was only a few websites out there and it seemed like everyone was applying to the same scholarships, making it unlikely that you would actually win any. Fast forward to today, and there are entire businesses like The Scholarship System that are focused on helping students win scholarships (and potentially fund most/all of their college costs). There are also a number of books available for less than $20 that focus on helping students find and win scholarships.
While I am very much focused on helping people who already have student loan debt, the sense I get is the more time and energy you put into understanding how to find and win scholarships, the more likely it is that you will succeed. It seems like many students and parents of students only dabble in scholarships briefly and, in turn, have little success. If a student treats it like a part-time job I think the chance of success greatly increase.
- Community College
I work at one of the biggest healthcare companies in the world. One of the other interns in my cohort graduated from a comparable college as me. The only difference, though, was he went to community college the first two years to knock out classes for (much) less than the cost of 4-year college. We both graduated with similar degrees from similar colleges, and received equal job offers upon graduation.
So many of those who are struggling with student loan debt today wish they had gone to community college for a couple of years and then transferred to the college they graduated from. Don’t get me wrong, there is a ton of value in going to the same college for four years, but if we are talking a pure financial standpoint community college can be a huge win.
- Focus on Financial Awards
Financial aid awards can be confusing. They use a wide variety of terms to describe what is essentially a loan. And if you don’t read through the letter carefully it can be difficult to carve out how much of the award is loans.
What matters is how much debt a student has to take on to attend a college. For two comparable colleges, if one requires $15k in loans and another $30k, it’s obvious which one would be a better deal for your children.
Obviously every parent would love to be able to tell their children that they saved enough to cover all their college expenses. But for many parents this is simply not a wise choice. Ultimately your child has a bunch of options, and even if they do go into debt there are options available to them, as I outline in my book Student Loan Solution.
I know many reading this may have very young children, but when the time comes be open and honest with your children about how much you can contribute to their college expenses. If you weren’t able to set aside anything for them, explain why. They may not appreciate it at the time, but they may understand down the road. And if you want to help, look into some of the options and strategies for cutting the cost of college such as scholarships and community college.
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