Dave Ramsey’s 7 Baby Steps: Step 5 – College Funding For Children

Last time we looked at Baby Step 4, investing 15% of your gross income into Roth IRAs and other pre-tax retirement accounts.   We looked at the magic of compounding interest, and why it’s in your best interests to start saving earlier rather than later.

Before we jump into step 5, here’s a review of the baby steps.   Haven’t read the others yet? go back by clicking the link below.

Dave Ramsey’s 7 Baby Steps

• Step 1 – $1,000 to start an Emergency Fund
• Step 2 – Pay off all debt using the Debt Snowball
• Step 3 – 3 to 6 months of expenses in savings
• Step 4 – Invest 15% of household income into Roth IRAs and pre-tax retirement
• Step 5 - College funding for children
• Step 6 – Pay off home early
• Step 7 – Build wealth and give!

Baby Step 5:  College Funding For Children

Now that you’ve got you’re out of debt, and saving 15% towards your future retirement, it is time to start thinking about saving up for your children’s education.  Remember, you don’t have to go into debt for your child to go to college.    Start saving for their education once you’ve finished baby steps 1-4!  Encourage them to get good grades, and help pay for their education through grants, scholarships and other free money.

Here are a few good options of ways you can save for your child’s education:

• Education Savings Account (ESA): You may save $2,000 (after tax) per year, per child that grows tax free!  Beneficiary must be under 18 years old.  Money must be used for education purposes only. Otherwise, a 10% penalty and taxes will apply.  Money must be used or rolled over to a qualifying family member by age 30 or a 10% penalty and taxes will apply.  Singles with an income over $110,000 – or Married couples with an income over $220,000 are not eligible.
• 529 Plan: If you do not meet the income limits for an ESA, or if you want to save money above an ESA, you can use a certain kind of 529 plan. You can save up to $12,000 per year, per child in a 529 plan.  The money must be used for higher education only.  Otherwise, a 10% penalty and taxes will apply to the gains only.
• UTMA/UGMA Plans: UTMA (or UGMA) stands for Uniform Transfer (Gift) to Minors Act.  According to Dave Ramsey, while this is one way to save with reduced taxes, it is not as good as the ESA or 529 plans.

While the above plans are highlighted as good ways to save for college, Dave Ramsey also lists several ways he would NEVER suggest using to fund your child’s education.  Be wary of these things:

• Insurance
• Savings bonds (only 5-6% growth)
• Zero-coupon bonds. (only 6-8% growth)
• Pre-paid college tuition (only 7% inflation rate)

ESAs, 529 Plans and UTMA/UGMA Plans are the way to go!

Why Other Things Come Before Your Child’s College Fund

Many people will get upset at the notion of funding their children’s college fund only when they’ve reached step 5.   They think that by not funding their child’s education until they have all their debt paid off or retirement funded that they’re in some way being selfish or harming their child.

In reality, I would say that you’re doing a lot more harm if you don’t do baby steps 1-4 first.   Your kids can always help pay for their own schooling or get scholarships, grants or loans.   But if you don’t get rid of your debt and start saving for retirement you may never be able to catch back up, and who knows if you’ll be able to rely on social security for anything in your old age.  Better to get your financial house in order first, and then help where you can.

Here are a few reasons why I think that education funding should come only after you’ve gotten out of debt, saved up your emergency fund and invested for retirement:

• Taking the time to make sure you are secure in  your retirement first takes a burden off of your children later on.
• Being responsible in getting rid of debt and saving for retirement sets a good example for your children, helping to lead them down the right path.
• Allowing your children to take on even a part of their school costs helps build character and makes their education mean more.
• Encouraging children to get good grades and participate in helping pay for their own college will help promote responsibility.

Personally I think that even if you are able to pay for your child’s schooling outright, it’s a good idea to have them participate in paying for their own schooling.  They can do that either by saving up for college through after school jobs, getting good grades that lead to grants and scholarships, and by going to in-state schools that cost less.   I talk more about those ideas in this post.

Here’s a funny quote from Dave Barry speaking to the idea of encouraging our children to succeed:

I believe that we parents must encourage our children to become educated so they can get into a good college that we cannot afford.  – Dave Barry

How My Schooling Was Paid For

When i was growing up it was made clear to my brothers and I that my parents wouldn’t be able to pay for all of our college, the money just wasn’t there.   They did have some money saved for us, but the amount was limited.

Because we knew that college wasn’t going to be free, we knew we would have to work hard and go out for grants, scholarships and other financial aid.   It gave us another reason to succeed.

I worked hard and I graduated with honors.  I was able to get quite a bit of my schooling paid for through grants, but the rest was paid for with loans.

The only thing I think I would do different if I could do it again would be to save some of the money I was earning in my part time high school jobs. If I had done that I would have been able to cut short the amount of money I had to borrow, and have paid off those debts a lot sooner than I did.  Thankfully I went to an in-state school which meant my education didn’t cost nearly as much as it could have elsewhere.  I have friends who went to comparable out of state schools who ended up having to pay 4-5 times as much as I did.

Moral of the this article?

• Realize and enforce the value of education even when the children are younger.  Encourage them to succeed to help pay for their own schooling
• Encourage in-state schools, or for some techincal schools (not everyone is going to be a doctor or a rocket scientist!)
• Help where you can by saving in an ESA or 529 plan,  but don’t give a free ride!
• Realize that going to college doesn’t have to mean going into debt.  Save for them, have them to save some on their own, and encourage them to succeed in school.

Next Up: Baby Step 6 – Pay Off The Home Early

Baby step 6 looks at taking extra income and putting it towards paying off your home early. Can you imagine what you could do if you didn’t have a house payment?

What’s your opinion of paying for your kid’s college?  Are you saving for their college funds? Will they have to pay for part of it themselves?  Let us know in the comments.

Tagged as: Baby Steps, college, Dave Ramsey, FPU

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