College Savings

Some estimates put a private university like MIT or Harvard at $95,000 per year for tuition and housing by the time our girls reach college age. That’s a lot of money, so we’re happy to say that we’ve started saving for college for Eleanor and Miranda. Overall, saving for college ranks below several other priorities for our budget, but on the other hand, the sooner we start saving, the more time we give for their savings to compound. Our financial priorities for this year have been:

1. Ensure that our monthly expenses don’t regularly exceed our income.
2. Rebuild our six-month emergency fund which has been partially depleted by our minivan purchase. The target amount for this fund has also grown because we spend more money per month now that we have the girls.
3. Ensure that our retirement investments are fully funded. If we don’t save enough for college, the girls can always take out loans of their own. We can’t do the same for our retirement investments.
4. Start college savings plans for Eleanor and Miranda and set up a recurring investment in them.

We considered four different college savings options: a 529 Plan, an UGMA/UTMA account, an Education Savings Account (ESA), and a 529 prepaid tuition plan. We eliminated the last option because our girls may not attend an in-state college (neither of us did), and the plans seem restrictive in terms of what we could invest in. The ESAs have a $2,000 annual contribution limit, which we may not reach, but the contributions are also limited when your income reaches a certain level. The UGMA/UTMA accounts are essentially a way of directly transferring money into your kids’ names. They’re okay, but you can’t change the beneficiary of the account. They may also have a strong effect on our girls’ eligibility for financial aid since the money is considered theirs. We finally decided on a 529 Plan. These plans are funded by after-tax money and the earnings are exempt from federal taxes and sometimes state taxes. The beneficiary can be changed to someone else if either Eleanor or Miranda decide not to go to college. Finally, the money doesn’t really affect Eleanor or Miranda’s financial aid eligibility since the money stays in our name. On a side note, the federal tax exemption is currently set to expire in 2010, but we’re hoping that this exemption will be renewed long enough for Eleanor and Miranda to benefit.

The next step was to decide which 529 Plan to pick. We were really choosing between the Golden State SholarShare program offered by the State of California and the Vanguard 529 College Savings Plan offered by the State of Nevada. The California plan offers investments by TIAA-CREF, which are very decent. The withdrawals will be tax-exempt from both federal and state taxes since we live in California. It offers some decent age-based investments which change their asset allocations automatically as the girls get older. The management fees are slightly on the high side at 0.80%, considering that the investments are mostly in index funds.

The Vanguard plan offers Vanguard funds, which we like enough that we use them in our Roth IRAs. The fact that this plan can be managed along with our IRAs (combined statements, a single website, etc.) is a bonus. Like the California plan, it also offers age-based investments, which are mostly invested in a combination of index funds. The earnings are exempt from federal taxes, but the girls will probably need to pay California state taxes. At 0.60%, the Vanguard plan management fees are lower than the California plan’s. It’s not easy to say if the lower management fees will be a bigger benefit than having the earnings be free of California state taxes. We ran some numbers based on some assumptions about the girls’ incomes when they are in college and the results are pretty close, with a slight advantage probably going to the California plan. In the end though, we chose the Vanguard plan because the comparison was so close and we already have other Vanguard investments. The girls’ 529 Plan accounts are now open, and we have a regular monthly contribution going into them.

One extra bonus of the Vanguard plan is that it can be linked with a UPromise account. A UPromise account gives you money back for various purchases that can be put into your college savings plans. Some people are uncomfortable in giving UPromise enough information to track their purchases, but on the other hand it’s free money. We signed up for it. Friends and family are also welcome to sign up for a UPromise account with Eleanor and Miranda as beneficiaries.

For people who are looking for more information on these different options, we recommend Saving for College, Morningstar’s College Savings Section (free registration required) and Vanguard’s College Savings Section. The Vanguard material was probably the clearest of the three, but the first two are good neutral sources of information.

One last thing to note about 529 Plans is that anyone can help us out with putting money into them. If you’re feeling generous, please contact us about helping us save for college!