Allowance

April marks National Financial Literacy Month in the US, so why not take this time to learn (and teach) about money? It can be difficult to understand money at a young age because children cannot make money through employment like adults do. By the time children reach an age where they can work for money, they have already witnessed many financial transactions and have pre-determined values and practices around money. There is a void between when children form money habits and when they can start to earn money of their own. That is the case for an allowance — to fill in this gap.

Once children are old enough to start helping around the house (usually by age 3), it’s time to consider an allowance.

Just like money doesn’t come free for adults, children should “work” for their allowance, doing things like household chores or achieving good grades. Once children are old enough to start helping around the house (usually by age 3), it’s time to consider an allowance. Other than money that is gifted and the occasional lemonade stand (or passion project), an allowance gives children money of their own to manage.

Deciding on all the rules around an allowance requires some planning ahead. Here are some questions to think about.

  • Does the amount change every year based on bills or obligations that the child assumes, such as a cell phone, or school lunch, or gas? Or does allowance simply increase by a pre-determined amount each year?
  • What frequency makes the most sense — weekly, bi-weekly, monthly?
  • Would it be easier for you and your child to handle allowance in cash or through direct deposit or cashless transfer (Venmo, Zelle, etc.)?
  • What situations warrant a partial or zero allowance?
  • Does paying allowance rely on task completion? If so, how do you measure and monitor on an ongoing basis?

Ideally, the requirements are the same for each child and do not stray from the plan over time, but you can certainly make exceptions if financial circumstances change. Pay reductions and unemployment happen in real life, so the allowance may have to be lowered or paused at times. On the flip side, when times are good, consider adding a bonus for a job well done or starting a matching contribution when certain savings milestones are met. An allowance should teach about both the good and bad times.

If you’re puzzled on where to begin with an allowance, stick to this simple plan. Base the amount of allowance on the age of the child, and pay on a weekly basis. For a child who is 3, the allowance would be $3 per week. For a teenager who is 15, allowance is $15 per week. This continues until your child starts working or graduates from high school, whichever comes first. Lean towards paying allowance in cash, so that your child can hold the true fruits of their labor.

Once an allowance is in place, then all the other lessons about money become easier to learn. A good first lesson is Share, Save, Spend. From there, help children understand taxes by automatically deducting a household tax. Instead of paying $4 per week, the household tax reduces allowance to $3 per week. Set up an auto-savings for one-third (1/3) of the allowance to deposit directly into a bank account for long-term savings. If children need to borrow money, ask them to come up with a payment plan, and reduce allowance by the amount of the payment plan accordingly. These are the lessons that will mentally prepare children for a future of managing their own money.

Happy Financial Literacy Month!

Homework: There’s no such thing as free money! Before starting an allowance or making the next allowance payment, parents and children can collaborate together on a chores chart or achievement chart to earn that allowance.

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The Rhyme And Reason For A Roth IRA

Rap Ode To Roth IRA

Here's the thing about Roth IRAs.
Pay taxes now, no delays.
You won't owe any more while your investments grow.
Once you're ready to retire, it's ALL your money to sow!
Add contributions up to the annual max, 
Then pick the investment(s), and see how it stacks!
Don't touch the money before age 59 1/2,
'Cuz taking earnings early costs a penalty and tax.
Don't wait! Start a Roth soon as you can,
Earn that compound interest -- That is the plan! 

The topic of retirement savings is especially pertinent right now for two reasons: either people are considering tapping into retirement savings as cash runs short or on the opposite end, they are looking to invest more money while market prices are low. One type of retirement savings account, the Roth IRA, caters to both. Let’s dive deeper into both scenarios.

Roth IRA – Taking Money Out

Contributions to a Roth IRA can be withdrawn with no penalty and no tax at any time, as they were taxed once already. This is one retirement savings vehicle that offers more withdrawal flexibility than others. However, earnings, or how much your money grows, are subject to both tax and a penalty if taken before age 59 1/2. There are some exceptions to this rule, but a Roth IRA is largely meant to be used for retirement savings.

In response to financial hardships caused by COVID-19, the CARES Act changed a few rules this year. For those in financial need, the early withdrawal penalty on Roth IRA earnings is waived for 2020, and distributions up to $100,000 are allowed before age 59 1/2. These distributions of earnings are considered income and will be taxed as such, but there is the option to spread the tax burden over 3 years or pay back the “loan” within 3 years to avoid paying taxes. Before you withdraw from your Roth IRA, carefully consider what this means for your retirement. In addition, taking money out of any investments could mean selling at a loss. Consult your financial advisor and tax advisor if you are contemplating a withdrawal of retirement savings.

Roth IRA – Adding Money In

For those in a position to invest right now, adding money to a Roth IRA (up to the max) not only takes advantage of stock market lows, but also yields more tax savings down the road if you expect to be in a higher tax bracket in the future. The Roth IRA works especially well when investments have a long time horizon for growth because you get to keep every penny gained without sharing a cut of the profits with taxes.

An attractive option this year may be a Roth conversion, which converts an existing IRA to a Roth IRA by paying taxes on the amount converted. If your income is lower this year than most years, you may fall in a lower tax bracket and therefore, pay less tax on that Roth conversion than you normally would. Furthermore, as a result of the market downturn, your investments may be worth less than previously, so less taxes would be owed. It’s a good idea to check with a financial advisor and tax advisor before making these financial decisions.

Making The Right Choice

No matter the impact that COVID-19 has on our financial lives, savings are still important. In fact, times like these make us realize that having savings gives us one more safety net when falling on hard times. So regardless of whether you are saving for retirement or saving for a rainy day, the point is to remember to SAVE!

Homework: Pay tax now or pay tax later? One reason to choose a Roth IRA (pay tax now) vs. traditional IRA (pay tax later) is if you believe your tax rate will be higher when you withdraw the money. Use the following math problem to understand the difference.

Say you earn $5,000 this year that you pay 20% tax, or $1,000, and you decide to contribute the remaining $4,000 to a Roth IRA. You add no more money to that investment, and it averages 6% annual growth over the next 36 years — How much will your total investment be? (Hint: Use the Rule of 72 to get $32,000 for the Roth IRA.) Assume instead that you defer paying tax until withdrawal by investing the full $5,000 in a traditional IRA– How much will your total investment be after 36 years of 6% annual growth? ($40,000.) After 36 years, if your tax rate is 20%, your total investment will net the same amount in either the Roth IRA ($32,000) or traditional IRA ($32,000) after taxes. If your tax rate decreases to 15% after 36 years, the traditional IRA ($34,000) nets more than the Roth IRA ($32,000). If your tax rate increases to 25% after 36 years, the traditional IRA loses ($30,000), and the Roth IRA wins ($32,000).

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Back To Basics

As a result of the financial turmoil caused by COVID-19, there is a lot of confusion about what is the best thing to do with your money? Let’s face it. Watching a paycheck disappear or get reduced is scary. And seeing investments bounce up and down daily can be unsettling. During uncertain times like these, it’s important to keep to the basics.

Just as you use a compass to navigate through a storm, use the following basic principles to point you in the right direction.

  • Focus on your rainy day fund. Although you might need to lean into your emergency fund right now, that doesn’t mean squandering it away. Try to preserve cash as best you can, and use a budget to identify where you can reduce expenses. You may already notice your discretionary spending has gone down with shopping malls closed and social outings cancelled, but challenge yourself to find extra ways to cut costs. If you are still receiving a paycheck, devote more cash to your reserves. Getting a tax refund? Put it in your cash reserve. Expecting a stimulus check? Put it in your cash reserve. When you can keep a steady 3- to 6-month emergency fund (amount depending on your level of comfort), then you can shift focus towards other financial goals.
  • Don’t sell your investments in a panic. Despite the stock market taking a bumpy ride, now is not the time to sell all your investments. Doing so could lead to significant losses that you may not recover once the market rebounds. A 401(k) loan or IRA loan may sound tempting, but taking money out of your retirement accounts could mean selling investments at a loss. Keep that in mind when weighing this option.
  • Avoid debt if you have cash. More options have become available to delay bills, like mortgage and rent payments. Be careful to examine what this means for your financial future. Simply put, these are loans, which means they must be paid back someday. Are you certain you can pay back the balance by the imposed deadline? What if, in the post-coronavirus world, wages are lower, and income doesn’t cover regular monthly bills along with what’s owed? For these reasons, it’s best to consider borrowing as a last resort, when all other cash is depleted.
  • If you have money to invest, dollar-cost average. For those who have a comfortable rainy day fund set aside and have spare cash outside of those reserves, you may be wondering what to do with your spare cash? Assuming that you’re not tapping into that emergency fund, there is no need to hoard more cash than you already have. Now that stocks have dipped to lower prices, it’s a great time to buy shares at a discount. But instead of timing the market, divide that investment over a period of time, otherwise known as dollar-cost averaging. As long as you keep a long-term outlook, chances are pretty good that you’ll come out ahead.

Navigating through a financial rough patch may seem complex, but doesn’t have to be with these basic principles in mind. As we go back to normal, these principles shouldn’t go away. Saving for a rainy day fund is always a good idea, as is keeping a long-term outlook on investments and avoiding the cycle of debt. Stick to the basics, and your money will stick with you!

Homework: To emphasize the importance of a rainy day fund and maintaining a comfortable amount, try this game with a deck of playing cards. How does your number do?

How To Play: Once the cards are shuffled, remove half the deck, and place the other half face down. You will draw from this half. Start with a number between 0 and 60; a multiple of 10 works best. As you draw a red card, subtract the number on that card from your original number. As you draw a black card, you have 2 choices: add that number or toss it. For example, drawing a red card with 6 means subtracting 6, and drawing a black card with 5 means adding 5, or 0, depending on how you decide. Royal cards and aces equal 10. If your deck includes jokers, add 10 when you draw a joker, regardless of red or black card. If your number ever dips below zero, game over. If you successfully finish through the half-deck, what number is left?

In this game, each card symbolizes money. The original number and ongoing tally is your rainy day fund. Red cards symbolize unforeseen expenses. Black cards represent income, which you can either save (add) or spend (toss). Joker cards can represent a rare windfall, such as stimulus money. Finding the right number for your “rainy day fund” and maintaining that number is key to winning the game!

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Money Lessons At Home

Now that everyone is home due to Coronavirus COVID-19, it’s a great chance to spend that quality time together brushing up on subjects that school may not focus on, like learning about money! Here are some suggested activities that can make learning about money FUN!! Some ideas come from personal experience, but I found neat ideas from others too, so click through the links to learn more. And of course, there is one more fun activity you can do on family game night — Monopoly! Happy studying, ACE!

Activities (Sorted By Grade Level)

  • Preschool – Kindergarten
    • Share, Save, Spend – Review the purpose of each bucket before beginning. Give play money (or real coins), one bill/coin at a time, for your child to place in 1 of 3 buckets. At the end, count the money in each bucket. Was the total amount distributed evenly?
    • Compound Interest In MarshmallowsThe Marshmallow Game is all about delayed gratification and the rewards that come with it. If your child likes something better than marshmallows, use that treat.
  • Grades 1 – 6
    • Mini Society – Find goods around the house to buy and sell to each other. This exercise teaches negotiation, pricing, supply and demand, entrepreneurship. You set the rules in this market!
    • Heads Up! Money Style – Ellen Degeneres’ popular cell phone game, Heads Up!, may not have a category for finance/money, but that shouldn’t stop you from making one. Write money phrases or words on index cards, and then place all the cards on a table, with the words facing down. The words can be simple, like “credit card,” or a little tougher, like “401(k).” Now let the guessing begin! Do your kids understand each financial concept?
  • Grades 7 – 9
    • Get A Job! – Parents should post chores around the house as jobs for hire. Children can practice writing a resume and then interviewing for the part. Parents can either pay real wages or reward with TV/tablet time. This mom actually held a job fair for her kids!
    • Stock Market Investor – Starting with a hypothetical investment of $10,000, pick 10 stocks for your portfolio. Track the investments over a year, and see how they perform. Just because it is fake money, don’t make decisions that you wouldn’t normally make! Get to really know your risk tolerance and investment style.
  • Grades 10 – 12
    • Beans for BudgetsThis activity is brilliant and works for college kids too! It’s better with small groups, but it can still work on an individual. You start with 20 beans that you decide where to “spend” them on. Occasionally something happens that causes you to re-think where you put your money!
    • Decoding Documents – It’s time to get acquainted with what bills and paychecks look like. Take a handful of real statements — paystub, investment, credit card — and learn what each line means. Are you ready to graduate from the school of personal finance?

Homework: What other activities help to learn about money? Contribute your ideas in the comments!

Spring Break: Ace Academy will skip the next two weeks’ lessons and be back in session during the first full week of April. Stay safe and healthy!

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Target Date Funds

Set it, and forget it!

– Ron Popeil
(Infomercial King,
Founder of Ronco)

If you are watching your savings go up and down in the stock market with a queasy stomach, you’re not alone. The natural human reaction when this is happening is to take all your investments and cash out. But that’s exactly what fuels a downturn in the stock market, a mass sell-off when too many people cash out at the same time. Panicked investors are actually selling low, instead of selling high when the market is doing great. How do you avoid this gut reaction to follow the herd?

If you’re the type of investor who gets nervous during stock market drops, you would benefit from something called target date funds. To understand target date funds, we first need to understand mutual funds. A mutual fund, which can be shortened to a single word – fund – is a bundle of investments purchased altogether. This bundle may contain only one type of investment, like a stock fund or a blend of types, like stocks, bonds, commodities, etc. The bundle might even be comprised of multiple funds, in short, a fund of funds.

To visualize this, say you are at a farmer’s market, and you buy some carrots, celery, and lettuce. Those veggies bundled altogether are like a mutual fund. Now let’s bundle another set: corn, cucumber, and zucchini. That’s another mutual fund. Bundle the two veggie sets together, and you have a fund of funds. A huge benefit to using mutual funds is the diversification it offers in one investment. With the veggies we bought, you can make veggie soup on a rainy day or salad on a sunny day. Mutual funds offer the same variety, so that you have some investments that perform better than others at different times. They also cost less bundled together than purchasing each investment by itself.

When you select a mutual fund, you automatically accept all the investments bundled within. There is no hand-picking like you do with individual stocks or bonds. A mutual fund has one or more mutual fund managers who pick for you. It’s almost like enlisting someone to do your farmer’s market shopping for you. At times, the fund manager(s) may decide to change some investments inside a mutual fund, like switching one stock to another. This is much like picking strawberries over watermelon, based on what’s in season.

As you can guess, this carries a cost, known as the expense ratio. It is not a dollar amount, but rather a percentage (%). So if the fund averages a 10% return that year, and the fund’s expense ratio is 1%, you see a 9% return on your money. If the fund loses money, that same expense ratio still applies. Try to find an actively managed fund with a low expense ratio (around 1% or less), and you’ll still be better off than trying to match the time and expertise of a fund manager when picking investments on your own.

Now let’s get into target date funds. A target date fund is also a mutual fund, in which the investments within change from aggressive (more stocks) to conservative (more bonds/cash) as you near a specified target year. As an example, Fidelity Freedom 2055 Fund currently contains 93% stocks and 7% bonds, whereas Fidelity Freedom 2020 Fund contains 54% stocks and 46% bonds. Why switch from more stocks to less stocks? The idea is to get more return by taking on more risk when you have many years before you plan to take money out of the fund. As you get closer to your target year, being more conservative allows you to withdraw money without worrying about swings in the market and without suffering big losses when it’s time to cash out.

Although you have many choices where to invest your money, a target date fund is a simple choice that gives you the sophistication of investing in many areas while not needing to check your portfolio every minute of every day. Think of it like auto-pilot. You buy just one target date fund, which is already diversified with many investments inside, and stick with the same investment until you need to use the money. This is the ultimate investment choice for someone who wants to, as Ron Popeil put it, “Set it, and forget it!”

Homework: Are you a target date fund or an a la carte kind of investor? Where could a target date fund work well for you?

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ABC’s of Health Insurance: From HMO to PPO

With the spotlight on coronavirus, medical care and the means to pay for medical care become ever important. Just one visit to the doctor averages $200-$600, and hospitalizations cost anywhere in the tens to hundreds of thousands of dollars! Most people do not have that kind of money laying around, and even if you do, would you want to spend it all on medical bills? Health insurance allows you to pay only a fraction of the cost of medical care, while the insurance company pays the rest. Like any other insurance, you pay on a regular basis for the insurance, no matter if you are sick or healthy. But in the event that you require medical attention, the cost of care won’t become a huge burden to your finances.

The case for having health insurance can be a topic of debate, with some countries mandating universal health care through public funding and taxes and others leaving the decision up to the individual. Given the cost of medical care nowadays, the case for having health insurance seems like an easy choice. What’s not so easy is deciphering the language of health insurance, especially when deciding which insurance plan to choose. Use the glossary below to help you “talk the talk” of health insurance!

Glossary

  • Coinsurance: The percentage (%) you owe for medical services. If your coinsurance is 20%, you pay $50 of that $250 medical bill (or 20% x $250).
  • Copay: The fee per doctor visit. A $25 copay for an office visit means you only pay $25 for the visit, instead of the full rate. Some insurance plans use a copay for urgent care visits and ER visits too.
  • Deductible: The amount you pay before insurance benefits kick in. For example, if you have a $1,000 deductible along with 20% coinsurance on a medical procedure that costs $5,000, you pay a total of $1,800 = $1,000 deductible + $800 coinsurance ($4,000 remaining x 20% coinsurance). Ever hear of high-deductible health plans (HDHP)? That means the deductible is higher than normal, usually starting in the thousands of dollars.
  • EPO: Exclusive Provider Organization, or EPO, is a type of health insurance plan that restricts all medical benefits to network providers and hospitals. Any care sought outside of the network will not be covered.
  • HMO: Health Maintenance Organization is another type of health insurance plan that adds more restrictions, but offers lower medical costs like little or no deductible and lower coinsurance. The main difference between an HMO plan and EPO/PPO plan is that the HMO typically requires a referral from your primary doctor to see anyone else for a medical problem. In an effort to keep costs low, it is rare that you will ever be referred out-of-network, so when choosing an HMO, make sure you are comfortable with the network of providers and hospitals.
  • HSA: Health Spending Account, or HSA, allows you to save money from your paycheck to be used solely for medical expenses (cannot be used for premiums). The benefit to using an HSA vs. paying from your own pocket is that money saved in an HSA never gets taxed. For instance, if your income tax is 13%, only $1 of every $1.15 earned goes in your pocket. Fifteen cents ($0.15) goes to taxes. Putting that money in an HSA means you get to keep the entire $1.15, but only spend it on health care.
  • In-Network: These are the preferred providers for your insurance plan. In-network providers and hospitals charge a lower copay or coinsurance than out-of-network options. With HMO and EPO plans, your benefits may not even extend beyond in-network providers, so seeking care outside of the preferred provider directory would mean paying for medical expenses on your own.
  • Out-Of-Network: Health insurance companies require you to pay more to see out-of-network doctors and hospitals. In the case of HMO or EPO, you will likely pay the full rate to seek out-of-network care, since no insurance benefits apply.
  • Out-Of-Pocket Max: Once you spend the out-of-pocket maximum for the year, the insurance will take over all expenses beyond that limit. Let’s say your out-of-pocket max is $3,000 in a given year, once you have paid $3,000 in medical expenses that year, the insurance will pay any remaining or future medical expenses for the year.
  • PCP: Primary Care Physicians, or PCP, are the doctors who provide general care like conducting annual physicals or treating common colds. They refer you to other doctors, or specialists, when the medical issue is beyond their scope. HMO plans usually require selecting a PCP, so all care must either be performed by or referred by the PCP.
  • PPO: Preferred Provider Organization, or PPO, is a type of health insurance plan that allows you to see any provider you choose, no referral necessary. It costs less to see in-network doctors compared to out-of-network doctors, but you have freedom of choice. This choice comes at a higher cost to you, which becomes noticeable in the deductible or coinsurance. If the PPO plan carries a low deductible or low copay and coinsurance amounts, you will likely pay a higher premium for that plan.
  • Premiums: The premium is what you pay on a regular basis for health insurance. If your employer offers health insurance, they usually pay a significant portion of the premium, and you are left with a smaller chunk of the premium. That is why when people leave or lose their jobs and elect to keep the health insurance plan (otherwise known as COBRA), they notice a spike in insurance premiums. The insurance company is not charging more. It’s just the combined cost of paying both employee and employer premiums.

Homework: What type of health insurance do you have? HMO, EPO, or PPO? Become familiar with the deductible, copay and coinsurance. How does the plan suit your needs?

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Diversification

Ever hear the saying, “Don’t put all your eggs in one basket?” Just like eggs, your money is fragile. If the basket drops or breaks, you’re out of luck. That is why you need diversification. Essentially, diversification means spreading your money (eggs) into more than one investment (basket). This way, if one of your investments loses money, at least you have other investments.

What “baskets” can you choose from? First, you need to decide on a type of investment for each basket. The types of investments can be exhausting and some types even offer derivatives, so let’s just keep it high-level: cash, stocks, bonds, real estate. We previously covered these types of investments in the lesson on Compound Interest. So many choices! With diversification, you don’t have to choose just one, in fact, you should spread your money across them all.

“Baskets” are not to be confused with accounts. You can have one account with many investments inside. For example, your retirement account may have a blend of stocks, bonds, and other investments.

There’s more to diversification than deciding what type of investment to place your money in. Diversification extends to the sector you’re investing in as well. Let’s use stocks, which carry a lot of variety. You could invest in telecommunications, medicine, entertainment, finance, and the list goes on. So instead of choosing just one sector, invest your money in different sectors to allow for the best outcome if one or more of your sectors hits a rough patch.

If you are an employee of a publicly traded company on the stock market, your company might give the option to purchase company stock at a discount or they may offer company stock as one of the choices for investing within the 401(k) plan or you can simply choose to invest in the stock in your own brokerage account. It’s tempting because it’s an easy choice. Be very careful when choosing to put money into company stock. While it’s fine to invest in the company you work for, after all it’s a show of pride and support for your work, you don’t want to place a lot of “stock” in one place (couldn’t help the pun!). Think of it this way. What if the company takes a tumble on the stock market and as a result, lays off a bunch of employees, including you? Now you’ve lost both your salary and savings, if you invested your savings in company stock. So again, while it’s ok to invest in your company, limit your investments there, and remember to diversify!

Diversification is a timeless strategy that you can use for investing, but it becomes particularly useful when markets are taking a dip. That is because you may see a lot of your investments lose money, but if you diversify, some investments may trend the other direction, up. It’s important to diversify your investments across as many possible areas, so that you can brave the roller coaster of investing like a pro!

Homework: Choose 3 stocks from different sectors to follow over the course of one week. How did they perform compared to each other? If they all lost money, expand your stock selection to 10 stocks the following week. Was there one sector that did better than the others?

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America Saves Week: February 24-29, 2020

Next week marks an annual campaign that started in 2007 and continues this year 2020: America Saves Week. Even if you do not live in the United States, it’s a neat way to keep savings top of mind. Each day — February 24 to February 29 — is a new savings focus. And the great thing is, we already covered the topics in past lessons! Next week is a great time to refresh your understanding and act on your knowledge! Here is the focus for each day of America Saves Week and links to past lessons that match the daily focus.

Monday, February 24: Save Automatically

Tuesday, February 25: Save with a Plan

Wednesday, February 26: Save for the Unexpected

Thursday, February 27: Save to Retire

Friday, February 28: Save by Reducing Debt

Saturday, February 29: Save as a Family

One of the best ways you can embrace this challenge is to set a simple savings goal. Baby steps are easier to achieve and when done over a period of time, add up to BIG savings. For instance, increase your retirement 401(k) savings by 1%. Or ask your family to skip one day of buying coffee each week and put that money towards a savings goal. Add an extra $20 each month to your rainy day fund. Whatever you decide to do, be proud that you are taking a huge step by making savings a priority!

Learn more about America Saves Week by visiting https://americasavesweek.org/

Homework: There is one day missing from America Saves Week — Sunday. What savings tagline would you give that day? What simple savings goal did you come up with?

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Paying For College: Ways To Save

Last week, we examined how decisions play an important role in paying for college. This week, we look at ways to pay for college. While parents usually assume the responsibility of funding their kids’ education, kids can also be involved in saving for their own education. Let’s look at the ways to save and pay for college.

529 Plan

One of the most popular ways to save for college is through a 529 plan. Named after Section 529 of the IRS tax code, you guessed it! There are tax benefits to saving in this type of account. The main tax benefits are that your savings grow tax-deferred, and your withdrawals are tax-free if used for qualified education expenses. Depending on the state you live in, contributions to the 529 plan may be deductible for state tax purposes, but are not tax-deductible on federal taxes. Not all states offer a 529 plan, but you can still open a 529 plan offered by another state. Keep in mind that a 529 plan is like the flower pot we reference time and time again. You choose the “seed” investments that go in the account, so you can gain or lose money, depending on how your investments perform. We’ll take a deeper dive into the 529 plan in the future, but there is a good introduction provided by the U.S. Securities and Exchange Commission.

Prepaid Tuition Plans

We won’t spend much time on Prepaid Tuition Plans because only a few states offer this option. If you live in a state that offers this option, the plan allows you to buy future credits at today’s tuition prices. As an example, if one course credit costs $1,000 today, but doubles to $2,000 by the time you go to college, you essentially got a 50% discount on education. Think of it as locking in tuition at today’s prices. The downside to this plan is that you are pretty much stuck with choosing a participating in-state college. Although your state’s Prepaid Tuition Plan may offer some portability to other in-state and out-of-state colleges, the penalties and reduced benefits of choosing non-participating colleges make other savings options more viable.

Non-Qualified Account

If you want the most freedom and flexibility, then a non-qualified account will be your best choice for college savings. This can be through a bank savings account or a brokerage account (which allows for investments beyond cash). Like a 529 plan, your savings can go up or down, based on what you invest in. Unlike a 529 plan, your earnings don’t receive any tax benefits, so taxes take a bigger chunk out of savings. However, you can use the money however you choose, even if it’s not for college. The previous options are not as forgiving when withdrawing money for other non-education expenses, charging an extra 10% withdrawal penalty, in addition to taxes on withdrawals.

Financial Aid

We mentioned last week that scholarships are worth a try, since they are essentially free money that does not have to be paid back. Grants are also free money, but not everyone qualifies for grants because they are based on a family’s financial need. Another need-based option is work-study, where students are given a part-time job to earn money while attending school. Finally, if there is not enough money to pay for college upfront, you can borrow money in the form of student loans. While you are required to pay back the money with interest, the interest rates on student loans are relatively low compared to other types of loans, and you usually have a grace period after graduation before repayment begins. Both parents and children need to be involved when it comes to financial aid – scholarships, grants, work-study and loans. The other options begin years in advance, sometimes as early as birth, so parents typically shoulder the responsibility of saving. On the other hand, financial aid planning happens the year before college, so children have reached an age where they can and should be involved in financial decisions.

As a reminder, college decisions are just as important as saving for college. That’s why both parents and children need to be educated (excuse the pun!) when it comes to paying for college!

Homework: Students, test your business skills by giving parents a presentation on 3 different colleges and how you would pay for each one. Whatever format you use to present, be prepared for Q&A at the end!

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Paying For College: Decisions, Decisions

At a recent speaking event, I was asked by a concerned parent, “How do I prepare financially for my kids to go to college?” As important a role as parents have in funding college, the kids have an equal if not greater role in the cost of college education. That is because the kids are the ones applying to schools and deciding where they apply and ultimately where they attend. This question inspired me to answer with a two-part post on Paying For College, with this post intended for future college students and the next post intended for parents or whoever will be paying for college.

Kids have a lot to consider when deciding where to attend college. Let’s weigh the financial impact of those decisions.

State school or private school? When we hear names of private universities like Harvard or Stanford, we all know they come with a hefty price tag. Based on those two colleges, $50,000 a year seems to be the going rate as an undergrad. Is it worth paying all that money to go to them? Maybe. But if you can’t readily afford $50,000 a year, will you be earning enough money after college to pay back your student loans? Do you even want student loans to eat a portion of your paycheck after college? US News & World Report calculated in-state tuition to be 73% less than private colleges. Imagine your favorite gadget or clothes at 73% off. That’s a hard deal to pass up! If your heart is still set on being an Ivy League grad, perhaps it’s worth considering a transfer after you have attended a year or two at a state college. Just remember, there is more than one path you can take.

Live at home vs. dorm/apartment? Another reason to consider an in-state college is to save on living costs. Living away from home can be pretty expensive. Not only do you have the cost of boarding, but you also have to think about food, laundry, dorm/apartment goods and travel to/from home. These are conveniences you didn’t have to worry about when you were in high school. Are you moving your car with you to college? That’s another bundle of expenses, from gas to parking. Living costs are probably as big a decision as college tuition itself.

To work or not to work? In addition to studying and partying, you will probably end up working during college. How else do you afford your college lifestyle? While a job teaches valuable lessons and can propel your future career, it can detract from your time and attention. Keep this in mind before you choose a college with a price tag that requires you to work. On the opposite end of the spectrum, there is the option to take a year off to gather working experience and build savings before continuing education. Some employers even offer to pay for a portion or all of your education expenses. Only you know what options are right for you, but the point is — you have options.

Scholarships and financial aid? Just like you apply for colleges, you can also apply for financial aid. Don’t be afraid to try for scholarships and financial assistance. You’re already filling out forms and writing essays for college applications. What’s another application? You might need some help from a parent to fill-out financial aid forms, but otherwise, this falls in your ballpark. You have to make the effort to apply!

These are some important considerations that not only impact your college decision, but also impact the rest of your life. So even if you’re not the one paying for college, your decisions matter!

Homework: Time to do some research! How much is tuition at colleges you like? What would your living situation be, and how much would it cost?

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