Dave Ramsey’s 7 Baby Steps: Step 5 – Work on College Funding for Children

If you have children, the question inevitably arises whether or not you should save for their college education. Once you’ve destroyed your non-mortgage debt and built your fully-funded emergency fund, you’re ready to start thinking about your kid’s future. In this baby step, we’ll explore how to put your kids through college without incurring hefty student loans.

Dave Ramsey’s 7 Baby Steps

• Step 1: Save up $1,000 to start your emergency fund.
• Step 2: Pay off all non-mortgage debt using the debt snowball.
• Step 3: Save up 3 to 6 months of expenses to complete your emergency fund.
• Step 4: Invest 15% of household income into Roth IRAs and pre-tax retirement accounts.
• Step 5: Work on college funding for children.
• Step 6: Pay off your mortgage early.
• Step 7: Build wealth and give!

My kids can pay their own way!

Some parents choose for their children to pay their own way through college. I understand this concept, as it does teach children to save and be responsible from a very young age. The benefit of having your children pay for their own college education is that they learn money is finite; it doesn’t grow on trees (if you find a money tree, let me know)!

On the other hand, college tuition is inflating at a rate nearly double that of standard annual economic inflation. This is concerning. By the time your child reaches college-age, it might be rather difficult for them to pay their own way through academia. Therefore, I believe Dave Ramsey’s Baby Step 5 is crucial for your children’s long-term success. Start saving now!

The Purpose of College

Dave makes is clear that the purpose of a college education is not to ensure success, but rather to encourage success. Higher education is more of a luxury than it is a necessity. Success is built from knowledge, not a pedigree or your degree. College is one factor that can encourage a higher income, and therefore relatively important.

Dave’s Rules of College

There are two rules of college that everyone must follow while on The Total Money Makeover:

1. Pay cash. In other words, don’t take out student loans! You never know if you’ll land that killer job after you get out. Many get stuck flipping burgers straight out of college, and they have to still pay off those loans while making minimum wage.
2. If you have the cash or the scholarship, go. This is basically repetition, but you need to have the cash to be able to attend. As long as you are able to cash-flow tuition, you should be fine.

ESAs and 529s

So how do you save for your child’s college education? First, start as early as possible. Second, save in either an Education Savings Account of 529 Plan. Here’s a general breakdown of each and what they mean for you:

• Education Savings Account (ESA): This is a savings account that is sometimes nicknamed the Education IRA. It grows tax-free when you are using it for higher education. This tax free growth over the course of 10-20 years can result in plenty of cash for your child’s education if you are investing in growth-stock mutual funds. Dave prefers this method of saving.

If you invest $2,000 a year from birth to age eighteen in prepaid tuition, that would purchase about $72,000 in tuition, but through an ESA in mutual funds averaging 12 percent, you would have $126,000 tax-free. - The Total Money Makeover

• 529 Plan: These are state plans that allow you to save money in one state and go to a college in another state (if you desire). 529 Plans are great for those whose income rules them out for an ESA. The best 529 Plan available is a “flexible” plan.

This type of plan (flexible plans) allows you to move your investment around periodically with a certain family of funds. A family of funds is a brand name of mutual fund. You could pick from virtually any mutual fund in the American Funds Group or Vanguard of Fidelity. You are stuck in one brand, but you can choose the type of fund, the amount in each, and move it around if you want. This is the only type of 529 I recommend. - The Total Money Makeover

But I’m running out of time!

Remember Dave’s two rules: pay cash and go to college if you have cash and/or scholarships. Your kids should only go to college if they can pay cash or you can pay it for them. In trying to accelerate the process of education, you could be setting your kids up for failure if you encourage student loans.

If you’re running out of time and the kids need to go to college now, WAIT. That’s right, you need to wait. Get gazelle intense and save up money as quickly as possible. Try reasonable cash-flow techniques. You can do it!

After you have your college-saving habit in place, it’s time to focus on paying off that mortgage in Baby Step 6! Join us next time for some great tactics on eliminating your last debt.

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