How To Save For Education and College – Rental or Home Equity vs. 529 Savings vs. Roth IRA vs. Whole Life Insurance vs. Other Business
I have been wracking my brain since our son was born 6 years ago on how to save for College and education costs in general. Do we invest in a 529 savings plan, or invest in a Roth IRA, or invest in Whole Life Insurance or invest in Real Estate or do some other business?
In this blog I’m going to give you the PROs and CONs of each strategy.
I will also be transparent in which strategy we our using for our son Jordan.
Rental or Home Equity
So far our strategy has been to buy an investment property, where short term vacation renters pay the mortgage and costs, and then when he’s old enough to go to College, we’ll refinance or do a Home Equity Line of Credit to pull out the equity.
I recently spoke to another Mom who has the same strategy for her 4 kids. In their case, they own a house as their investment property which they rent out to long term renters.
Now, it’s not always easy to find an investment property in Hawaii, most don’t really yield a return higher than 4%.
We currently have 1 investment property and it’s currently yielding us about 6% (including principal payments on equity). This will only increase every month as the mortgage is paid down, and as profits increase and our operations stabalize (this is our first AirBnB business).
We also have our home, which we just bought in June. We currently don’t have a roommate, though we have a room that rents out for $800/month. Currently without a renter we are making 5% return.
Now, this all assumes that the real estate we bought remains the same value when Jordan goes to school. It also assumes interests rates, state excise, state transient rental taxes and property taxes remain the same.
The value of our condos may increase or decrease. Trends in condo prices in Oahu at the moment are on the down. We bought this condo in June at $25,000 less than asking ( this is after they reduced the price $10,000).
Owning property is more time intensive. If we rented we could tell the landlord to fix everything. We obviously have to fix our own place ourselves with our own time and money.
So far, I’ve also been handling repairs for our investment property as well.
As we scale up, if we decide to scale up, we will then need to hire a property manager.
If you are depending on your home equity for retirement, or you are overextended on your current housing costs, then this may not be a good strategy for you.
If you don’t know what you are doing, you can lose money buying property as well.
We bought a home where the costs of owning were comparable to the costs of renting.
We bought an investment property that we estimated would create 16% annual return on our cash investment without including equity.
529 Savings
A popular option for savings for education and college is the 529 savings plan. Your contributions are after tax, however, all growth is tax free as long as you use the money for tuition to College and some other qualified education expenses like books.
In addition, if your kid doesn’t go to college, you can use it to go back to school, or use it for your grand kids, etc.
The reason we have not started one is mostly because the State of Hawaii gives no tax benefits for contributing, we were wary of the funds available to us at the time and we decided to focus on real estate investing.
Now, I recently revisited the 529 plans and have discovered that since the Hawaii plan has no tax benefits, I can look at other states that allow non-residents to join their plans.
In fact, after calling a TIAA-CREF, I was shown that some states such as California have very low fee index fund plans (0.08%).
CLICK HERE for a fee study of all 529 plans.
After reading Tony Robbins book Money: Master the Game, and also A Random Walk Down Wall Street by Burton Malkiel, I have started taking an interest in investing in the All Seasons Portfolio with index funds.
The All Seasons Portfolio was shown in Money: Master the Game to grow at an average rate of return of over 9%, and it requires way less work than rental property…like spending an hour a year to re-balance!
Some people worry that the government does take consideration of 529 plans in calculating financial aid. I’ve read that savings investments have only 5% weight in the calculation of financial aid. Income is by far the biggest factor in determining Financial Aid, not savings and investments.
Well, I went to calculate just how much of a difference it would make if we saved up $100,000 or even $200,000 in 529 or rental property, and it had no effect on the amount of financial aid we would qualify for (which was $1,465 in work study and $5,500 in a Direct Stafford Loan).
CLICK HERE and Calculate for yourself!
In any case, for us, a 529 would be beneficial because the growth is tax free (assuming it grows).
Roth IRA
The next savings vehicle I’ve been recommended for College savings is the Roth IRA. Now, the reason for that is because you can use the money for other things besides education…such as buying your kid a car or a house.
A Roth IRA is funded the same as a 529 with after tax money, and the growth is also tax free as long as you don’t withdraw it before you are 59 1/2 years old. What if you are younger than that when you need the money for College?
You can withdraw up to the amount that you’ve put in at anytime without paying any penalties or tax.
So, if you have deposited $15,000 into your Roth IRA, and you are younger than 59 1/2, you can pull the $15,000 out tax and penalty free for college or anything else.
If you had kids when you were in your forties, and one of you will be 59 1/2 years old by the time you need money for your kids college, then the Roth IRA may be preferred over the 529 Savings, as you can use it for more than just tuition and books.
You can use it for your kids travel costs to and from college like a car, or gas, or just paying for a plane ticket to go visit or fly them back for the holidays!
Now, if you are looking for Financial Aid, withdrawing from a Roth IRA does affect your income, and income is a much bigger factor in calculating financial aid than investments (even if it’s not taxed).
Of course, this is only a factor if you even qualify for financial aid. Use the calculator to see if you do or don’t.
Click here for an excellent article comparing 529 Savings Plans to Roth IRAs.
If you think you would qualify for financial aid, then a 529 Savings might be better if you are saving for education and college, and will not be using it for anything else.
Whole Life Insurance
My insurance advisor and my accountant use whole life policies in their children’s names as a savings strategy.
Now, the insurance advisor, I understand as he make commissions but my accountant?
So I’ve been looking at this option for a while and I think it’s only good for people who feel like finding good bonds paying more than 2-3% is impossible, the stock market is going to bust and stay busted for the next 12 years, and real estate is too complicated or risky.
It’s like forced savings where you don’t see any return on your savings for 11 years or so (in fact, it’s worth less than what you put in until you get to this point).
So if you start when you’re kids are born, and the policy has been in force for 18 years, then there is an annual return on the cash value of about 3% last time I calculated.
That return is better than current savings account rates.
Now, if you put in paid up additions (if you have a rider that allows you to buy more insurance coverage within your current policy), those paid up additions are added to the cash value.
Here’s an example from a great article from Investopedia explaining Paid up additions in Whole Life Insurance:
Example of Paid-Up Additional Insurance
Consider a 45-year-old male who purchases a whole life policy with an annual base premium of $2,000 dollars for a $100,000 death benefit. In the first year of the policy, he decides to contribute an additional $3,000 to a paid-up additions rider. The paid-up additions will give him an immediate cash value of $3,000 while adding $15,000 to his death benefit. If he continues to purchase paid-up additions, he will continue to increase his cash value and death benefit as time goes on.
So, with this information, if I do paid up additions, since all of my money goes into cash value (instead of only some of it when I do my premium payment), then the paid up addition money yields the going rate of the policy, which is 5.85% for 2019. It has been 5.85% for the last 3 years. I found my rate here.
So I guess over time if you do enough paid up additions your ROI can go up from 3% to around 5% depending on what the life insurance policy is paying out. My policy has a floor of 4% dividend, so unless the company is in financial difficulty, they will pay at least 4% no matter what interest rates are.
So, if you are thinking of opening a savings account, instead of or in addition to investing in some other vehicle like the stock market, then Whole Life Insurance can yield you a better return while your child is growing up than a regular savings account or bonds (as long as the insurance company you have the policy with is financially sound).
High yield savings accounts are yielding about 1.9% APY as of this writing.
In addition, savings accounts interest is taxable.
Life insurance dividends that are used as paid up additions to increase cash value are not taxed unless you withdraw it out of the policy. If you take out a loan from your policy, then there are no taxes owed, as long as your keep paying your premiums and your loan is in good order. However, there is a sizable interest rate of around 7% on the loan (check with the insurance company to find the exact loan rate).
It gets even more complicated when you learn that the dividends that are paid to you are on the cash value – and a loan does not decrease the cash value for the dividend calculation.
So, if you have $10,000 in cash value,
and the current dividend rate is 5.85%,
and you take out a $5,000 loan at 7.5%.
You will pay $375 ($5,000 x .075) in interest/year.
However, you will get $585 in dividends ($10,000 x .0585).
So, you could choose to have your dividends pay down your loan balance every year until it’s all paid off.
I haven’t done this paid up additions strategy yet because honestly, I felt we could invest the money in real estate and make a higher rate of return than 3% – 5%.
However, I may consider this strategy if I feel we want to invest in more conservative bonds, and bond rates remain lower than 3%.
Other Business
If you have extra money to save, you might want to invest all or part of it in a business.
By the time your kids go to college, maybe your business will have grown so that you are making enough money to pay for it.
In addition, creating and growing a business is an excellent way to give your kids business education while their growing up.
It’s a great way to educate yourself.
My investment and time in growing my internet and coaching business has actually given us tax savings, as well as given me skills that I never would have learned if I had stayed at my bank job.
There are so many business opportunities and ideas.
You can buy a franchise, maybe go into network marketing, cater from home, babysit or start a daycare, bake, sell jewelry, create the next instagram…
Robert Kiyosaki in his book Rich Dad’s Guide to Investing recommends this method for those who want to become rich.
Learning about creating, operating and growing business is a key factor in becoming a great investor, as you will understand better the businesses you are investing in.
I just finished speaking with a Tardus representative today who was telling me about their patented Snowball strategy which if we decided to pay their $5,000+ coaching fee, they guarantee they will make us our coaching fee back in new passive income.
He also mentioned buying interest in public storage and claiming part of the depreciation, investing in a website creation platform where you get a portion of all money made on the ads from websites created on the platform, rental real estate in other parts of the U.S., investing in trailer parks…
The point is that there are plenty of other business ideas, opportunities and strategies to make the money you need to get your kids to College.
Conclusion
Right now, our strategies have been the home and rental equity and other business.
I have been wary of the stock market, and have heard that this past year, it had zero growth.
According to Burton Malkiel’s book A Random Walk Down Wall Street, it’s useless to try to time the market. Just get in and invest every month and you’ll equal the average growth of the market (which as been 9%).
The All Seasons Portfolio recommended by Ray Dalio also had an annual average growth of 9%, with much less volatility (worst year was -3% during the housing crisis).
I hope this blog helps you in starting to save and/or invest for your child’s College education costs.
In all instances, the earlier you start, the better.
You can also start small. Whichever strategy you choose, I recommend monthly deposits that you increase over time. We increase our monthly deposits by 10% every 3 months.
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