Save for College and for Yourself
Reena and Will Watts may have an impulsive streak — they married just eight months after their first date — but they are careful with their money. They've managed to amass $25,000 in an emergency account, enough, they figure, to carry them for six months.
Wild spenders? Hardly. Will packs his lunch every day, they don’t even own a TV, and “we never cut our son’s hair,” Reena says, half-jokingly. Her voice soars when she compares the cost of living in Kentucky to what it was when they lived in California. “It’s 100 percent cheaper,” she says. Their grocery bills are down by half, gasoline is cheaper, and baby sitters charge $10 an hour, a 50 percent drop. They are putting down more than 20 percent on a $162,000 house, which helped them secure a 30-year mortgage at an affordable interest rate of 5.25 percent.
Their only extravagance — and it’s a biggie — is their private-school ambition for their son and for the two siblings they hope to give him in the years ahead.
Although neither Will nor Reena was raised in an especially religious household, since meeting they have become devout Jews. They are set on sending their kids to Jewish day schools. But, as Schlesinger points out, it’s hard to see how they could underwrite such an expense unless “somebody is expecting to inherit about $5 million.”
OK, that’s an exaggeration, but not by much. According to Schlesinger, tuition rates typically increase at about twice the rate of overall inflation, or about 8 percent a year, which means the cost doubles every nine years. The Watts estimate that their son’s tuition will start at about $15,000 a year. If they have three children, their annual tuition costs could inch perilously close to $100,000 a year. And, remember, that’s before college. “They are going to have to make some choices,” says Schlesinger. After all, it’s also crucial for Will to put as much as he can in his 401(k) beyond contributing the 6 percent minimum required to get his employer’s match.
Make Saving for Retirement a Priority
As selfless as parents often like to be, saving for education at the expense of saving for retirement will almost certainly have bad repercussions for everyone concerned. After all, as Schlesinger notes, nobody awards scholarships or grants loans for retirees. “If you don’t have money, you can’t retire,” Schlesinger says.
With $10,000 a year in surplus income, the Watts aren’t going to be able to fund the kind of education they want for their children. For starters, they are going to have to start saving even more aggressively. At the same time, Schlesinger suggests, they should appeal to their parents and grandparents for help. Rather than accelerating the pay down of Will’s $69,000 in student loans, Schlesinger suggests that they use the cash freed up by the reduction in interest — it drops to a rock-bottom 3.37 percent in January — to help fund their child’s education.
Get the 411 on a 529 Plan
If you can afford to save for your children’s college education, you should investigate state-administered 529 Plans, which are a tax-efficient way to build that nest egg, Schlesinger says. As long as distributions are used to pay higher-education expenses, the investment gains on your savings are exempt from any federal income tax, and some states give residents a state income tax deduction for putting money away.
While you can invest in any state’s plan, in general, if your state offers a deduction, then “it’s a no-brainer” to choose your home state’s plan, says Schlesinger. If not, there’s no benefit to staying local, and parents should look for plans run by low-cost administrators such as Vanguard or TIAA-CREF. Use a direct plan, not a broker-sold option; returns on 529s aren’t going to be high enough to offset any commission expense.
If your state offers just a commission-based option, Schlesinger says, it’s well worth looking to other states. Utah offers a particularly good plan offering Vanguard index funds and very low fees. To research 529 plans, go to savingforcollege.com. For the Watts, Kentucky offers an age-based TIAA-CREF plan that looks like a perfectly adequate choice, but since the state does not offer a deduction, they’d be better off in the cheaper Utah plan.
Get an Estate Plan
As much as you may want to remain flexible in the future — Reena and Will certainly do — it’s crucial to prepare for any unpredictable disasters. Just pray they don’t occur. While Will has $250,000 of term life insurance, Reena has none. Schlesinger advises him to boost his coverage to a $1 million, 20-year level term policy. “The cost will be reasonable because of his age, and the term should be sufficient to cover the period when his kids will be young,” says Schlesinger. And it’s not just the breadwinner who needs coverage, although that’s a common mistake. As primary caretaker, Reena should have $500,000 in term life insurance.
But “the biggest hole in their financial plan” is reserved for an area that no mortal likes to think about, Schlesinger says. She advises them to get in touch with a lawyer and draft wills with guardianship instructions (right now, if they both died, the state would make decisions for Rafael). They also need to draw up power of attorney agreements (giving one of them decision-making authority over financial transactions should the other become incapacitated) and health care proxies (a similar document but for health care decisions).
With all of that out of the way, they can go back to doing what young couples do best: anticipate, with optimism. “I feel a certain pride that despite the general national mood, we can still take risks,” says Will. “I hope that we’re always willing to do that.”
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