How Team LSM Approaches Saving for College and 529 Plans

Mrs. LSM and I have slightly different approaches to how much money we should be setting aside for the kid’s college funds.  Perhaps unsurprisingly, both of our worldviews are shaped by the way that we went through school.

Mrs. LSM had to take out loans for school.  In her view, having to take out student loans will make the kids focus more, appreciate the value of the education that they’re getting, and think long and hard about the work/party balance in school.

My parents paid my college tuition, room, and board for four years (I was on my own for law school).  In my view, having to take out student loans hamstrings them in their early 20s – just the time when they could use the cash flow from their paychecks to launch their 401(k)s and get a headstart on their classmates.  We have the ability to fully fund their college careers, and so, I think we should.

Now, this is not to say that I intend to be a piggy bank for books, pizza, and beers for 5 or more years of college.  Cash flow being an important consideration, I think that we should be paying for the big costs – tuition, fees, and a roof over your heads.  But the kids should pay for everything else.

You want a car?  You pay for the gas and the insurance.

Want to backpack through Europe?  Buy yourself a plane ticket.

Want to join a fraternity?  Dues are on you.

Buy your own pizza and beer, kids.

We have three young boys: 5 years, 3 years, and 5 months old.  Since the day they were born, we’ve been depositing money each month into their 529 plans.

Section 529 of the Internal Revenue Code allows for tax-advantaged savings towards future education costs.  Up to $10,000 per year per beneficiary can be deposited into a qualified 529 plan and will then grow tax free (meaning any dividends or capital gains are not taxed – much like in a 401(k) or IRA).  The funds are then withdrawn at a later date tax-free as long as they are used for qualified higher education expenses (tuition, mandatory fees, and room and board).

As an added benefit, some states, our home state of Virginia included, allow you to deduct a portion of what you’ve deposited into a 529 plan from you state income taxes.  In Virginia, you can deduct up to $4,000 per year per beneficiary from your state income taxes.  Not coincidentally, we contribute $4,000 per year per kid to our Virginia 529 plans.

The returns have been reasonable, bearing in mind that we started contributing $333/mo. and have been dollar cost averaging ever since.

Our five year old’s plan is up 15%.

The three year old’s plan is up 11%.

The poor five month old’s tuition money is actually down about 4% thanks to a lackluster market in 2018.

At this rate, by the time they reach their senior year of high school, the $48,000 that we’ll have put aside for each kid will grow to about $90,000 for tuition, room, and board.

What I like about the Virginia 529 plan is that once you have it set up, it is braindead simple to maintain.  The plan pulls funds automatically each month and deposits them into a target date fund.  (There are other options – including a stock only plan and a “choose your own allocation” plan – but it seems easier to just have it re-allocate as the kids get older.)

Also, unlike many target date plans, the expense ratios are pretty reasonable – all but a few of them under 0.5%


One thing that we haven’t done yet is purchased any of the pre-paid tuition blocks.  Most states, Virginia included, allow you to purchase blocks of college education with today’s dollars for use at a later date.

For instance, in 2017, you could buy a Kindergartner one semester at a four year public university in Virginia for $8,485 in today’s dollars (or, you could buy a ninth grader the same amount of college for $8,145).

The reason we haven’t purchased any of these blocks is that we simply don’t believe that college tuition prices can continue to go up at present rates.  The same $8,485 invested in a qualified plan that returned 7% over 12 years would reach $19,109 by the time Junior goes to college.  Will tuition be that expensive in 2030?  Maybe.  But given the current student loan climate and what appears to be a migration away from the “college is the only path to success” mindset, I doubt it.

Which brings us to one last question: What happens if you’ve spent 18 years saving up college tuition and the kid doesn’t go to school?  Or goes to school on a scholarship?

What happens to the 529 plan if your child gets a scholarship?

First, though 529 plans are often used for college, they can be used for a wide variety of post-secondary education – from community college to trade schools to vocational schools.  If learning is involved, there is a decent chance it’s covered.  A good tool can be found at to determine if a particular school qualifies for a use of 529 funds.

Second, the plan actually belongs to the account owner – not the child.  So if the child decides not to go on to any secondary education, you can always just change the name of the beneficiary to any other family member – a sibling, cousin, grandparent (!) or even yourself can become the beneficiary.  The only catch is that it must be a family member.

Unfortunately, if there is no one else to shift the funds to and you have to withdraw the cash, you’ll pay a pretty large penalty.  You’ll have to pay the federal income tax on the capital gains and a 10% penalty.

If the intended beneficiary gets a scholarship and there is not another family member who you can shift the funds to, the tax code allows you to withdraw the cash and only pay the federal income tax (you don’t have to pay the 10% penalty).

How does your family think about saving for college?  Do you think it’s better for the kid’s sense of the value of a dollar if they have to know they’ll have student loan debt?  Leave your thoughts in the comments below.

The Most Important Question Service Professionals Aren’t Asking

A while back, I met with a potential client who was injured in a car crash.  He had been minding his own business and was on his way to work when someone ran into his car at a high rate of speed.  Everything about his case was one that we would be interested in: clear liability, significant injuries, terrible photos of the vehicles, and plenty of insurance coverage.  The meeting came to a grinding halt, however, when I asked him the most important question that I ask of any client:

What can I do for you?

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The most powerful question is the one that gets clients to stop and think about their motives for calling you in the first place.

Service professionals (attorneys, accountants, doctors) owe a duty to our clients from the very beginning to make sure that our goals are aligned with theirs.  If we can’t meet those goals (and can’t quickly change the client’s mind about what their goals ought to be), we should be declining to get involved.

In this case, the potential client wanted to go after a local law enforcement agency for a car chase gone bad.  From everything he had to say, I agreed with him.  The police force involved had ignored several safety rules that ultimately led to a car smashing into this man.  But police cases carry all sorts of special rules about immunity, gross negligence, and whether the police or the “bad guy” was the ultimate cause of the crash.  And anyway, because the value of personal injury cases is based on the injuries to the client and not on the conduct of the negligent party (in the vast, vast majority of cases), having the police officer as a defendant didn’t add one dollar of value to the case.  In fact, I told him, I could make a strong argument in favor of his case being worth less to a jury with the police officer as a defendant than it was with the guy he was chasing as a defendant.

Still, his primary goal was to hold the police officer accountable.  A noble cause, to be sure.  But my primary goal is to get my client’s as much money as possible in as little time as possible.  I viewed the route against the police officer as more costly, more time consuming, and ultimately less fruitful.  I was unable to convince him otherwise and we parted ways amicably.

The number one thing that I make sure to ask every potential client during the initial phone call, after they’ve told me the story of their case is,

“OK.  And what can I do for you?”

Frankly, most people are a little bit taken aback by this.  I can hear them silently thinking “You’re a lawyer.  I’ve been in a car crash.  You can help me.”

But the truth of the matter is that not everyone who has been in a car crash needs my help.  And there are many people who have been in a car crash who I don’t want to help.

I use that question – What can I do for you?  As a screening tool to make sure that the crazy people (“My case is worth $100,000 because my neighbor got $50,000 and he wasn’t even hurt.”) and to at least get the sane people to start thinking about the ultimate goal in their case.

In my experience, too many service professionals think that they know what the client’s goals should be without even asking them.  Here, I am thinking of those salesmen in the financial services industry with the one-size-fits-all sales pitch or the doctor who has learned a new modality that he believes is as a fix-all.

Hell, we’ve gone to school for 4, 7, or 10 years.  We know way more than these people, right?

Maybe.  But the time that you spend convincing them that you are correct is wasted energy.  Better to spend that time on cases and clients who you like, who like you, and who’s goals were aligned with yours from the start.

Setting Up an Emergency Fund

The emergency fund is a staple of the advice given by the personal finance community.  Suze Orman says that you should save enough to cover eight months of living expenses in your emergency fund.  Dave Ramsey says that you should save at least three months of expenses in an emergency fund if you have a double-income family and as much as six months if you have a single-earning family.

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The sad fact is that many Americans cannot weather even a minor emergency.  CNN reported in May of 2018 that some 40% of American households aren’t ready to handle a $400 emergency.

As a personal injury lawyer, I’ve seen it with my own clients – some of whom cannot afford the additional cost of physical therapy co-pays to the tune of $25/visit three times a week.  That simple additional drag of $325 a month is something that they just can’t keep up with.  They sometimes have to resort to signing away a portion of their claim to loan-sharking lawsuit lending companies.

Your bank account needs to be built to be able to take a punch.  The question is where to store the reserves.

I like to keep mine in separate buckets outside of my regular savings and checking accounts.  Since law school, I have maintained separate online savings buckets with Capital One (formerly ING).  These online accounts serve two purposes: First, they pay significantly more than brick-and-mortar savings accounts do.  Even with the paltry rates of 2018, 2% is better than 0.2%.  Second, they serve the function of keeping your emergency money separate and apart from your regular money.

I have “buckets” set up at Capital One for an Emergency Fund, but I’ve also opened separate accounts for things like home improvement savings, vacations, and saving for the down payment on the next car.  By compartmentalizing our funds like this, we don’t have to “remember not to forget” that the $4,000 we’ve been putting aside for vacation is sitting in the checking account.

If you don’t have an emergency fund, the best way to start one is in an online savings account, separate from your regular account and to set up an automatic online investment that pulls the money out of your regular account just as soon as it goes in.  I love this method of paying yourself first.  If you are funding an emergency fund with whatever is leftover at the end of the month, you are not likely to get the bucket all the way filled.  By paying yourself first, and then making it through the month on what’s left, you are!

The added bonus of this is that it creates a snowball effect.  Once you’ve filled your emergency bucket with auto-withdrawals, you can set up an auto-withdrawal into a brokerage account or increase your IRA or 401(k) savings with the amount that you were putting into the emergency fund.

IRA Limits Increase in 2019

For the first time since 2013, the amount that you can contribute to an IRA (Individual Retirement Account) will go up in 2019.  Regardless of whether you contribute to a Roth IRA or a Traditional IRA, folks under 50 will be able to contribute $6,000 in 2019.  Those over 50 and eligible for the IRA “catch-up” will be able to contribute as much as $7,000 in 2019.

However, income limits remain in place for Roth IRA contributions.

Roth IRA Contribution Limits

Roth IRAs are funded with post-tax dollars.  Once the money is in your account, it grows tax free and you can withdraw it in retirement tax free.  However, not everyone is eligible to contribute to a Roth IRA.

For a single tax filer, the phase-out begins at $122,000 and those who many over $137,000 may not contribute any funds at all to a Roth IRA (at least directly.

For the married tax filer filing jointly, the phase-out begins at $193,000 and you are entirely ineligible to contribute if your family earns more than $203,000.

The beauty of the Roth IRA is that once the money is in the account it is never taxed again.  If your funds were sitting in a regular brokerage account, you would be liable to pay taxes on dividends each year as well as capital gains taxes on any stocks or mutual funds sold.  In the Roth IRA, the funds are never again taxed – not even in withdrawal.

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Traditional IRA Deduction Limits – Spouse Covered By Retirement Plan 

Contributions to a Traditional IRA are tax-deductible in the tax year during which they are made.  Funds in a traditional IRA are considered tax-deferred.  You do not pay taxes on the funds during the year in which they go in and you do not pay taxes on dividends or capital gains during the growth of the money, but you do pay taxes on withdrawal.

In withdrawal, the money coming out of your IRA is considered income.  In many cases, however, you will be in a lower tax bracket in retirement than you are today and so you are effectively paying a lower tax rate on the deferred income that you otherwise would.

However, the IRS does not allow you to deduct taxes on your traditional IRA contributions in all cases where you or your spouse are covered by a retirement plan at work.

If your spouse is covered by a retirement plan at work, the non-covered spouse can deduct his or her entire traditional IRA contribution with joint earnings up to $193,000.  From $193,000 – $203,000, only a partial deduction is available.

Traditional IRA Deduction Limits – Taxpayer Covered by Retirement Plan

In cases where the taxpayer himself is covered by a retirement plan at work, there is still an opportunity to deduct contributions to a traditional IRA if you make below certain salaries.

A single taxpayer may contribute to both a 401K plan and may deduct his traditional IRA contributions if he earns $64,000 or less.  Again, a phaseout allows people making up to $74,000 to take partial deductions.

Married taxpayers filed jointly who are both covered by 401K plans or otherwise at work may still deduct their traditional IRA contributions if their earnings are less than $103,000.  And they may take a partial deduction as long as their total earnings are less than $123,000.