The Biggest Mistake High Earning Parents Make When Saving for College | Ep. 4
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Episode Summary
Many parents struggle with balancing their own financial goals while also wanting to provide opportunities for their children.
In this episode of Beyond the First Million, Gideon Drucker and Jordan Haines break down the key considerations behind education and family planning, including how to think about saving for college versus saving for retirement.
They discuss the benefits and flexibility of 529 plans, common misconceptions around education funding, and why financial planning decisions should be based on a family's overall goals rather than a one-size-fits-all approach.
The conversation also explores teaching children financial responsibility, multigenerational wealth planning, gifting strategies, and how families can use their wealth to create opportunities for future generations.
Topics Covered
It Depends: What Education Planning Really Comes Down To [02:18]
529 Flexibility, Beneficiary Changes & Legacy Planning [08:07]
Listener Question: Kids on Payroll vs. 529 [11:14]
Front-Loading the 529 Early [12:54]
Teaching Kids the Value of Hard Work Without Student Loans [16:12]
Other Education Savings Accounts: UGMA, UTMA, Trump Accounts [20:47]
Gifting Money: The Sandwich Generation & Annual Exclusions [22:26]
Giving Wealth While You're Alive vs. Leaving an Inheritance [24:14]
Resources & Links
Transcript
Below is the full transcript for Episode 4 of Beyond the First Million.
Introduction [00:43]
Gideon: Welcome back to Beyond the First Million. I'm your host, Gideon Ducker, alongside my co-host and colleague, Jordan Haines. How are we feeling today?
Jordan: Feeling great, ready to go.
Gideon: Yeah, we're excited for this episode. Last week we got into the weeds a little bit about what to look for when you're speaking to a financial adviser, you're thinking about hiring one, and some of the nonsense financial advisers sometimes like to talk about. Not us for sure, definitely not us, but other financial advisers.
Today we're talking about all things education planning, family planning, how to think about saving for college versus saving for retirement. And you'll be unsurprised to hear that we have thoughts about all of this. When it comes to family planning, education planning, we try not to get too deep into the weeds on naming individual types of accounts or strategies because I don't really think that's the point of the podcast. But I think that'll come up a little bit more here than maybe some other episodes because I just think it's kind of unavoidable talking about 529 plans, for example. We'll get a little bit deeper into the weeds on them as we go. But I think a good starting point for this conversation is... I'm stealing something that CPAs say all the time, but when people ask, "Should I do this or should I do this? What's the best tax strategy?" I'm putting you on the spot here, but what's the most annoying answer that CPAs give that nobody likes to hear, but it's generally true?
Jordan: I have no idea.
Gideon: Two words.
Jordan: “It depends”.
Gideon: There we go. We didn't even practice that, folks.
Jordan: I still got it.
It Depends: What Education Planning Really Comes Down To [02:18]
Gideon: It depends, right? Advisers, consultants in any shape or form... "Hey, should I do this? Is this typically better?" Well, it depends. I need to know more. And when it comes to education planning, that's really the case. We have given advice, I know both of us, our whole firm, of telling families they should make sure that they are on track to saving 100% of their kids' college in their 529s. Like they should have all of the resources dedicated to fully funding their kids' college with their education plans, with their 529s. And we have told other families that, you know what, you really shouldn't have more than 25% saved in a 529 plan for your kids' college, because it really depends. It depends on your income, how you're funding your other goals, your retirement, right? If you're trying to buy a vacation home, everything else you're doing. So every family is different. It really does depend. Maybe I think a starting point for that conversation of when do we typically recommend fully funding education, not doing so, is really unpacking the vehicles that are at a family's disposal.
Jordan: My question, which you answered already, but maybe that'll help you get back on the thread. We say it depends, but what are the main things it depends on?
Gideon: Yeah, it depends on how close are we to doing everything else we want to do in our financial lives, right? Somebody that comes to us that says, "Hey, I want to better understand how much I can put towards education." Well, they can only save at present 13% of their income, right? And they're saving $5,000 a month total. I don't know that we're really trying to divert that much resources towards funding your kids' college in 15 years when at present we're not even close to being on track to funding your retirement. Something I heard my whole life, you know, growing up in the business, hearing my dad talk about with clients, is you can borrow for college, you can't borrow for retirement. And I think sometimes parents love their kids more than anything in the world, right? And you're a parent. You want to make sure they're taken care of. I think sometimes parents focus really hard on that and think, "All right, we're going to fund college," and not thinking about the second and third effects of that, which are... sure, maybe we're funding college, but if we are not financially independent and taking care of ourselves, then our kids get to a point where they have to take care of us later in life because we don't have enough of a retirement nest egg, we don't have health costs covered... it's kind of like that you're in an airplane, right? What do they say over the speaker?
Jordan: Put your mask on first before your kids.
Gideon: That's kind of how we want to make sure we're helping clients. Mr. and Mrs. Client, you are who we're responsible for taking care of and we need to make sure you're on track for your goals the next few years and retirement, and then we want to make sure that yes, you are doing everything you can to pay for and fund your kids' college if that's what's important to you. But that really has to come third.
Now when people already have that right, because we work with a lot of clients that are doing a great job, they're saving a lot, and we can... I mentioned savings rate and I think that was the first time I've done that in this entire podcast, so maybe you can speak a little bit to what is a healthy savings rate, what do we want to look for there. But if you're already doing a great job of funding retirement, you're on track for all of your goals, that's where we land of why wouldn't we fully fund your kids' education through these super tax-efficient 529 vehicles. So maybe that's where we want to take a pause and just explain, maybe you can start off just at a high level... how does a 529 work? Some of the benefits, and I'll come in with maybe some of the added benefits that people don't think about right off the bat.
Jordan: Yeah, and I think before we define that, what I'm hearing from you, and those listening can take away, is you need to first be able to answer the question, "Am I on track to make work optional, or am I on track for retirement?" before you have that really in-depth, "Can I also pay for my kids' college or my kids' education in the future?"
Gideon: Right. Or can I pay for all of it, right? Because it's not binary. It's not either I'm helping my kids or not. It's to what degree.
Jordan: It's almost like then the next question is how much can I afford for my kids?
How a 529 Plan Works [06:14]
Jordan: So a 529 account, for those of you listening who have probably heard about it, what that is really in the simplest form possible is an investment account that has been set up with certain tax benefits specifically for expenses that you use for qualified education. When you invest money in a 529 account and you use that money for qualified education expenses, and frankly you just Google what those are, we don't need to get into the nuances of that, then those can be used tax-free, which is great. We don't want to have to pay taxes if we don't have to.
Gideon: So a 529 plan, you put money in, you get, depending on your state, a tax deduction upfront, right? In New York, you get up to a $10,000 state tax deduction. New Jersey, not so much. If you're above a certain income threshold, which most of our clients are, California basically tells you to go F yourself... they don't care where you put your money, you're not getting a tax deduction. So there is none for 529s. But most importantly the benefit is it grows tax-free, right. You invest the funds, it grows tax-free, and you take it out tax-free if used for qualified education costs, which are really substantial and expensive actually. Tuition, room and board, technology... I don't think they've quite made the beer tax-free, although maybe down the road. You can use it for K through 12, and again there's a lot of minutia, you can use it for a lot. But the benefits are that it grows tax-free and you use it tax-free. That is the core component that separates a 529 from everything else.
Now those are the basics and I think that's what people know about it. But the first thing that we hear when we explain, "Hey, you might want to use a 529," is people get freaked out. "Oh my god, what if my kids don't go to college? What if they get a scholarship? What if they don't need the money? We're shit out of luck." That's kind of what we hear. We spend a lot of time talking about, all right, well, you're really not. And there's a lot more flexibility than you think. So we're going to stay on that for a second.
529 Flexibility, Beneficiary Changes & Legacy Planning [08:07]
Gideon: 529 plans, you can change the beneficiary whenever you want. You have three kids and your oldest child gets a scholarship. You can just make the beneficiary your second or third child, and you can figure that out on the fly. You're not making that decision when they're four or five and deciding which of your kids you love more and want to go to college. You change that when they are getting ready to actually go. This is more recent over the last few years. You can move a portion of an unused 529 into a Roth IRA that you own. Right now it's limited, I want to say it's up to $36,000. Don't just ChatGPT that. But I suspect that number will keep going up because the government wants people to use more education vehicles. That's why they're making it easy to roll money out of the 529 into retirement, to give you more options.
I think the coolest one is how a 529 can be used for legacy and estate planning purposes. In my own family, my dad did this. When I was born, when my sister was born, my dad set up 529 plans for both of us. By the time we went to college, he ended up not needing to use the funds. He paid out of cash flow. I would have liked to say we got full scholarships and I'm just such a wicked super genius or tennis player, but that is not what happened. He just paid out of pocket. When my sister had her first son three years ago, my dad, who was the owner of the 529 plan and my sister was the beneficiary, he made my sister the owner of the 529 plan and my sister's son, my nephew, his grandson, Bodey now the beneficiary. So now my sister gets another... at this point, 14 plus years of tax-free growth. And my dad gets to set up multiple generations of the Ducker and Anipole families for college. And my dad has made it clear to me and my wife that if we don't get the ball rolling soon, my 529 plan is going to my sister, who's had another two kids since then. So that's more of a personal thing we've got going on. But that is how 529 plans work. You can spread it between your kids, among generations, you can use it for retirement.
And the absolute worst-case scenario, right, is let's say you put all this money into a 529 plan and 20, 30 years from now your kids didn't use it and you need that money for your own retirement. You pay a 10% penalty on the earnings. You put in $50,000, it grows to $80,000. You have $80,000 in the account. You're paying a 10% tax on $30,000... three grand. In the scheme of things, right? The risk-reward of overfunding education is... the absolute worst case, nobody in your family needs it, you don't roll it into a Roth IRA, you just need the money in a pinch, you're paying a 10% penalty. Compared to the underfunding... kids have to take out student loans, they can't go to the school they want. That is the way worse option. And I've never seen a client, quite frankly, in that worst-case scenario where they're paying that 10%, if they've done any manner of planning, I don’t think that’s on the table. But I do like to, with clients in any situation, say, "Hey, what would be the worst outcome here?" And then we review, "Well, how bad is that actually, and how bad is that relative to the risk of the best-case option?"
Listener Question: Kids on Payroll vs. 529 [11:14]
Gideon: Producer Sarah asks
Sarah: My children are on payroll for my company. Is it better to have them on payroll or fund a 529?
Jordan: Are they on payroll so you can do a Roth IRA for them?
Sarah: Yeah, I invest everything. It goes to payroll and then straight to a Roth IRA. It also reduces the business's taxable income.
Gideon: Yeah. I would say they're not mutually exclusive.
Jordan: If you only had the funds to do one or the other
Gideon: Then in that specific case, probably the way you're doing it makes sense because you're getting the additional tax benefit of paying them through the business. And this is a whole separate conversation that I don't even know if we're going to use in here, but you also have to pay your kids for actual work they are capable of doing in the business. You can't say your 8-year-old is doing your bookkeeping, right. The IRS looks at that and says, "What are we doing here?" Also, not every child can model for every business. Certain businesses don't need a three-year-old model. The IRS is also going to look at that. But yes, in that specific case, because you get the benefit from the business standpoint and you get the personal benefit, and you put it into a Roth IRA that is flexible for their future as well.
Jordan: You can withdraw from a Roth IRA with qualified education expenses sometimes, right?
Gideon: And the money you put into a Roth IRA, at least your contributions, you can take out without paying any tax or penalty.
Front-Loading the 529 Early [12:54]
Gideon: Education funding is a very specific time period, right? So it does add a level of... sometimes we're telling clients, a lot of times when clients have young kids, we're telling them to overfund their 529s early. We might say, "Hey, let's put $10,000, $20,000 into the 529 plan." And I always want to make it clear, we're not saying you have to do this for 18 years. But the more money you put into a tax-free vehicle early and the faster it starts compounding, right... think about a ball rolling down the hill. The higher the mountain that you're rolling the ball down from, you're gaining momentum, you're picking up speed, and you have to do a lot less the closer to the bottom of the mountain you are because momentum and gravity are doing everything for you. That's kind of how a tax-free vehicle like a 529 works. You put $20,000 in when the kid is 6 months old, and then 16 months old, and so on and so forth. By the time they're five or six, we might have $50,000 to $75,000 in that account. And who knows at that point, maybe we don't need to keep going. Probably you would, because in our experience once you start saving it's a habit, it's discipline, you keep doing it and you don't even notice it anymore. But when we say "Hey, put this amount into a 529," we're not saying you have to do this forever. We're saying start it, build momentum, build the compounding wealth in a tax-free way, and then we can reevaluate in a few years. We might want to turn that spigot off and add into something else.
Jordan: Yeah. I want to summarize what you've been talking about with 529s because I've experienced this working with clients, as I'm sure you have. I think a lot of people come to us concerned about the 529 as they are with sometimes other accounts as well, as like it creates no flexibility. I'm locked in, it's forcing them into doing something. And I think what I'm hearing from you is that it's not that... there is a lot of flexibility within the 529. If the principle is, "I want to help my kids out in the future, whether it's with education, whatever that is, I want to help them," this is a really good vehicle because there are a lot of options and flexibility within that account.
Gideon: And it ties... and this is why, when we say it depends or we have to know more about your financial life, this is what we're talking about. Now my story of my dad might, if you're 25 and straight out of school, the whole thing seems ridiculous. But if you're 40, you have a few kids, and you're on the path to financial independence... thinking about things to help your future grandkids, and a lot of times when I explain this to clients, I'm like, "Yes, I know it's outrageous to think of your little four-year-old, but you're on track financially and you can do things now to set your family up for generations."
Right. It's even when we think about investing, right? A lot of times we're talking to a 45-year-old and we say, "Hey, you might have a 50-year time horizon." In fact, I think if we do our job right, you actually have more like an 80-year time horizon because we're not just talking about your life. We're speaking about your kids, your grandkids. Now, again, this all stems from: well, how are you doing right now? Somebody that's not comfortable living day-to-day, sure, none of this resonates. But if we put the things in place where you know you're on track for retirement, you're saving what you need to, to get where you want to go... honestly, that's where the financial planning gets a little fun. You can think legacy, you can think what's most important to you. We haven't even touched on charitable giving, but that's something you can start thinking about. The complexity opens up, what you can do with your money opens up, both from a tax standpoint and just from a "Hey, what's most important to you?"
Teaching Kids the Value of Hard Work Without Student Loans [16:12]
Gideon: I'm going to flip it for a second, and this is probably the most subjective we're going to get in the podcast. A good planner can work with somebody, help them identify where they want to go, and make that happen. Somebody last week said, "I think there's something helpful or educational about making our kids have some student loans, that they have to work for it themselves, they have to figure it out, even if we're capable."
Jordan: What they're saying is... we want to instill hard work. Like, I want to teach them something through this process of them figuring it out on their own. Is that kind of what you're saying?
Gideon: Yeah. Now I love the idea and I think there are ways of helping, teaching kids about money and the value of a dollar, the value of hard work. I can share a quick story... I had two jobs in high school and one I quit after a day because I saw what the other one allowed me to do and gravitated towards that. But my answer to that client is, "Hey, I love the idea of making sure your kids understand the value of hard work. I think there are ways that we can set up your financial plan that don't require us taking out high-interest loans, that don't put your kids in the situation of having high-interest loans with a private university or federal loans. We can do that within the family in a way that... it's your money, you can do whatever you want to make sure they understand. But we don't need to involve outside parties and outside debt to make that lesson hit home." Yeah. I don't know. You have kids, I don't yet.
Jordan: I’ll give my personal example my wife and I grew up in very different families. She had a 529, her parents had funded it, her grandparents had helped fund it. But she and her siblings all worked really hard. Like the whole idea of working for your education and becoming a hard worker and these values you want to instill... those were there. You can teach hard work without having to take out student loans. It's not the only way.
Gideon: It can still be the expectation, right?
Jordan: Right and so you look at her and her siblings and they all got scholarships, they all got these things. Now they have these 529s that we can hand down to our kids. It's phenomenal, it's wonderful, we love it. Me on the other hand, I didn't have that. And I had to work a little bit. Halfway through college I got a job, paid really well, didn't have to work 90-hour weeks to do it, it was like 4 hours a week, and it basically got me through college. But it was wonderful because now it freed me up to work hard in other areas. So I think we sometimes attach, like, in order for me to teach my kids to make it for themselves and be independent, I can't give them anything. And I don't think that's true.
I don't know if that's a lesson we want everyone to take from this because everyone is so different, but there are ways... I think what you're getting at is there are strategies for the money to be there regardless.
Gideon: And that's really the point, especially when they're younger. Set everything up the way you want it, and then you have, as a parent, ultimate discretion. If you set up 529 plans and you don't want to use all of the funds, if you want to set up an investment account... we talk a lot about setting up just a regular investment account. Not going to get too technical because that's not the point, but an investment account that you and your spouse might own, but we separate organizationally. We might title it, for example, "For Jackie and Susan." Because it's meant for the kids. It's your money, you can do what you want with it. But when you're looking at your own net worth, you say, "Hey, this is money that we might want for their first car or an allowance." You're creating a situation where you're doing all the right financial strategies, you're saving, you're investing, you're separating funds for your kids. But it's your money to decide how and when.
I've heard this enough, of parents saying, "Hey, well, we want to teach...". Well I grew up with my dad as a financial planner. He didn't teach me when I was 8 or 10 or 12 about financial planning strategies. He said, "You know, be a kid. You'll learn this when you need to learn this." And the expectation was, you need to work hard in school, you need to get good grades. That is the expectation. Be on the sports teams, and when you're on a team, you train and you work your ass off. There's a way of expecting things at a certain level when you're at a certain age. And then when you get to that later point, you need to accomplish what you're working on. The end of all of that is... put yourself in the best footing where you're not regretting what you didn't do 10 years from now, because you might want to do things differently. Save money into the vehicles that are going to give you the most optionality, and then you have 15 years to figure out exactly how you want to do that.
Other Education Savings Accounts: UGMA, UTMA, Trump Accounts [20:47]
Jordan: The general theme from this conversation is there is a lot of flexibility when you're planning for your kids' education. It doesn't have to be one solution, and that's the only thing that matters. And frankly, the solution, like a 529 account that a lot of people already know about, has a lot of flexibility within it. But there's also, if you still want more flexibility, other strategies that can be done.
Gideon: And there are accounts we haven't even mentioned, in the interest of this not turning into a textbook. UGMA, UTMA, custodial accounts. I'm not a huge fan of those because I think it limits flexibility, because that money is your child's at age 18 or 21. If they want to go buy a boat or give it to their girlfriend, they can do so. And there aren't, in my opinion, enough other tax benefits to make me say, "Hey, that is a great possibility." Or even just... that money, you can't touch it until they're 18 or 21. So that's one we typically don't talk about, but it is another potential option.
Even like the Trump account, which is relatively newer. If you have a kid born between 2025 and 2028, there's free money. We like free money. Outside of that, it's like trying to do two things... in my opinion it's not as tax-efficient as a 529 or a Roth, and it's not as flexible as just a standard investment account. Again, I'm saying this quickly just to make sure we're covering all our bases, because yes, I think a 529 plan provides the most diversification and different ways of saving. But there are a lot of different ways to save for education. And to bring it back full circle... how should you save, what should you use? It depends.
Gifting Money: The Sandwich Generation & Annual Exclusions [22:26]
Gideon: We wanted to talk a little bit about gifting money. It kind of ties into this whole family planning conversation. I'm going to be brief on just a little bit of the textbook. I hear this all the time. A lot of times our clients are the sandwich generation, if you've heard that term, where basically you're in your 40s, you have kids that you need to take care of, and then you have older family members, parents that are in their 70s, 80s. Technically the sandwich generation refers to when you are financially helping both sides, right? So you're helping the generation below and the generation above. A lot of times our clients' parents want to provide for their grandkids. So a lot of our clients say, "Hey, what's the tax impact if we get a gift? If our parents want to send us money?"
So I always like explaining this because it comes up all the time. If you're the recipient of a gift, if your parents, your kids' grandparents, want to send you $19,000, there's no tax impact to you, and to your kids. You are able to receive a gift. You don't have to put it on your tax return, you don't pay taxes. It's the person that gives the gift that has any potential tax impact. And even then, if you give under the annual exclusion, which last year was $19,000, you don't have to do anything. You are allowed to give that amount. And if you're married, you can give double that, so it's actually $38,000. And then if your kid is married, you can give that to both people. So it extends out pretty significantly. If they give more than that, if they say, "Screw it, we want to give $100,000," any amount above that exclusion just comes off of their lifetime tax and estate exemption, which is over $13 million right now. So it comes off of that, which is obviously a huge amount. It might be lowered. It's always politically changing. But if you give below that, nobody is impacted from a tax standpoint.
Giving Wealth While You're Alive vs. Leaving an Inheritance [24:14]
Gideon: We just had a lot of clients, and I've written about this in other places. The traditional way of thinking is, "Well, I'll get money when my parents pass away as an inheritance." And I'm seeing a lot of change in that mentality, just more families being open about money. If you're 75 and your kids are in their 50s and 60s, when you pass at 85, is that providing the most benefit for everyone involved? Probably not, right? If you're in your 50s and 60s, you're probably in pretty good shape already. How much is your parents' money really changing your life at that point? Whereas if you can give more of your money away while you're alive, and your kids are in their 30s and 40s and they're in the most expensive phase of life... you know, if they have kids, they're paying for tennis lessons and family vacations and saving for college and all these things.
We've had a lot of these conversations because we've had the benefit of working with clients in their 30s and 40s, and also some of their older family members on the other side of our firm. For that 75-year-old to get to see your family enjoying the money that you've accumulated... like you're 80 and you get to see your grandson or granddaughter go to summer camp with the money that you gave. You take your family on a big family trip. You get to see the actual memories, the experiences that your money creates for your family. And then your kids get to use it in the time of their life where they can most use a little bit of a break. And again, this is all to say if the family is in that situation where they have the money. They don't owe their kids anything, and a lot of families obviously are not in that position. But if you are, we're having a lot of these conversations of, "Hey, how do we make sure this family money is benefiting the people at the right time?" And the people giving it... because it is a gift of love... it is getting to experience that money and the impact they have on their family.
So this is a little bit different than saving for college, but it's really part of that same conversation. And we hear all the time, "Hey, my parents also want to contribute to the 529 plans and they're trying to figure out how much they can give." That can be a motivating reason for somebody that's a little bit older to work with a planner, where they're past the point of understanding, "Am I on track for retirement?" Yes, they already are. And they've gotten to that point maybe without an adviser, maybe they had one. But now the question is, "All right, how much of our wealth can we give away, whether to family or to our charities, in a way that doesn't stress us out?" Because if you get used to spending and saving in a certain way your entire life, it can be very difficult. I like to say for our retired clients on the other side of our firm, what our firm helps them with is how to spend their money, not save their money. People genuinely need help learning how to spend their money when they spent 40 to 50 years learning how to save, invest, and put it away for a rainy day, and then realizing, "Oh, it is that rainy day, and it's now time to actually enjoy the fruits of our labors."
And the way we like to think about money is, we don't wait until we're 80 for that to happen. We want to be doing that in every decade. But it happens the most when you no longer have to save any more money. And that becomes a conversation. So we've met with clients where they bring their parents in because they're super open about money. They want to have that conversation where everybody knows where they stand and what is the best thing they could be doing collectively for the next 5 to 10 years.
Wrap-Up & Next Week [27:45]
Gideon: Good place to end up. We went into the 529s and came out talking about intergenerational planning. We didn't even expect to get there. But we appreciate you joining us this week. Next week we are going to be talking about probably the other biggest financial decision that we talk about with clients, which is home purchase planning. Buying a home is the single biggest financial decision clients ever make, the single biggest thing they ever spend money on. So how we think about that, the context surrounding it, we're going to dive into all of it. And if you have any questions, comments, anything you want us to speak about in upcoming weeks, please comment below. And we'll see you next Thursday for a conversation around home purchase buying.
