As many students prepare for their next chapter, you may be hearing conversations about college applications and acceptances rolling in. Even if you still have young children, these topics may have you wondering about the high cost of college, if you can afford your child’s preferred school, and how you’ll begin to save and pay for the various expenses. It’s natural for parents to feel stressed about preparing for these costs. In a recent episode of The John Chapman Show, John and co-host Erica Merrihew break down straightforward college-saving tips parents can use when their children are still young, as well as later when they’re ready to attend college. The strategies John shares are valuable if you’re preparing for college expenses—even if it feels like your financial margins are small.

John shares a strategy that uses three savings buckets:

A 529 College Savings Plan

John explains that investing in a 529 plan as soon as possible—when your kids are under age 10—is an essential piece of saving for college in the future. Why? You’ll benefit from tax-free growth and spending from a 529 for eligible college expenses. John and Erica discuss the details of a 529 plan, certain limitations to be aware of, and how you can significantly reduce or eliminate student loan debt.

Family Money 

Family money can come from your current salary, grandparents, or a portion of your non-retirement investments and can be provided at the time of college.

Non-family Money 

This money will also be provided at the time of college and can come from grants, your student’s part-time job, scholarships, student loans, or other financial aid.

Every family’s finances, goals, and circumstances are different, so it’s important to speak with a financial advisor, accountant, and tax professional to calculate your income and expenses and assist with your next steps.

Listen to the full episode to hear John explain each savings bucket in detail as well as hypothetical examples. He also shares the crucial conversations he believes every family should have before beginning a college savings fund—and it has nothing to do with finances. Learn more.

Audio Transcription

John Chapman: (00:00)

Hey everyone. It’s John Chapman. I’m joined by my co-host, Erica Merrihew. Erica, how are you today? 

Erica Merrihew: (00:06)

Good. Thanks John. For having me. I’m happy to be here.

John: (00:09)

I’m enjoying the spring weather. Erica, what are you guys’ plans for spring break this year?

Erica: (00:13)

Well, we live in Newport Beach, so we borrow our neighbor’s paddleboards. Often I attempt to go on the paddleboard. Sometimes I’m successful, sometimes I’m not, but we borrow our neighbor’s paddleboards and you know, it’s funny, John, speaking of my neighbor, the other day, we were borrowing their paddleboards and they have three kids. One’s a senior in high school and she was just talking to me about all the upcoming stuff that’s going on in her life, aka college applications. And so far, she’s gotten quite a bit of acceptances from colleges and she was kind of opening up to me a lot about a lot of questions coming up in a blink of an eye. Obviously her daughter’s now of age to go to college and she’s asking, gosh, how much is this going to cost? Can we really afford this amount? You know, will we have to take out loans? Pretty much this idea of where do I start? And it actually reminded me that there’s so many young parents out there that have no idea what to expect when it comes to college savings. And I would love it if you could just try to address some of those tips for young parents that are asking those hard questions.

John: (01:19)

It’s a timely topic. I know a few other people that are going through this process, too. It’s like, they’ve got a senior and they were doing all the applications last year and now they’re getting back the acceptances and trying to decide. And so I’m thinking, I think the best thing we could do, Erica, is maybe talk about families that have kids that are younger. Let’s say if I can even categorize us, people that have children under age 10. Now, when you’ve got a two-year-old, a five-year-old, and eight-year-old, it can set you up for so much success in the future and not feel like all of a sudden you wake up one day with a tuition bill on your desk, right? 

Erica: (01:59)

Yeah. All of a sudden it’s like, wait, where did this come from? I’m really glad we’re going to go through this, John, because you know, for my husband and I, thinking about college savings seems a bit daunting at times because here we are a young couple, we’re trying to have a regular retirement and investing savings and all of the other things. And sometimes I feel like after everything has its own bucket, there’s barely anything left over. So where do I begin in this process? 

John: (02:27)

I think that’s an important point. Probably the thing that I hear the most, the stress point, is where I have very little margin anyway, as it is. I’m trying to save for retirement. I’m going to pay for my mortgage. I’m going to do a little bit left over to go to my emergency fund or maybe my regular non-retirement investments. It’s like, what bucket am I pulling from to do the college fund and how do I even do that? And so I think the best thing I can do Erica today is provide a framework for three buckets. So that way folks can understand how the framework works, where they’re saving money from, how much they need to save right now, and how much they’re going to worry about later when their kid grows up.

Erica: (03:07)

I love that. Before you do that, John, can I share some, a few stats that I found online that were interesting? Cause I was thinking about this after I talked to my neighbor. I was like, you know what? I wonder how much college actually costs these days. And you know, at the end of their college experience, how much debt do they really have? And this might be interesting for the audience to hear. So tuition for in-state Cal State Long Beach is about 7,000 per year. Tuition in-state for UC Irvine is about 14,000 per year. So now you’re kind of doubling it a little bit. Tuition for USC is about 58,000 per year. And now you’re more than doubling it. Tuition for Stanford is about 53,000 per year. So the cool thing about all of it is there’s options. You know, every family is going to feel different depending on the spectrum of costs that are actually out there. And according to experience, the average, this was fascinating. The average college grad in California has about $40,000 in student loan debt when they actually graduate. So not only have they paid for college up to this point, but now they’re in debt with their student loans.

John: (04:18)

I have something that I’d like to be able to help my clients with, helping them with a plan so they could either minimize or completely eliminate any student loan debt for their children. And every family has a different circumstance. If they end up in debt, it is what it is. But I think as parents, we could do a lot ahead of time to map out our strategy and this actually makes me think of another thing, Erica. I think some of the subconscious stressors that are out there for young families and parents when they’re thinking about just educational costs, there’s also this subconscious question of what do we want the direction for our family to be? What do I want, what are my hopes and dreams for my son and daughter in terms of what their education and their career is going to be like?

John: (05:04)

And it’s just, there’s too big of an unknown, you know, we’ve got a five-year-old, a four-year-old, and a three-year-old and I just have no idea; how could I know today what their education needs will be? I think maybe even one step before we talk about the financial levels that I’ll skip over, but I want to be able to touch briefly right now is boy, you and your spouse need to have these important conversations about your goals and your values with your family, what you expect from your children and just get all that aligned up before I think you can go back to the financial piece, right?

Erica: (05:38)

Yes. That is such a good point to bring up before we even get started on that financial piece. You know, this could be part of why people unconsciously, like you said, get a little stressed. It’s not just about deciding how much we’re going to save, but the bigger question, you know, we all hope our kids are honest, hardworking, confident, well-rounded. But then the second question, like you said, was what type of values? Of course we want our family to hold our morals, truths, and beliefs close to us when it comes to making decisions about money savings and preparing for college. So this is nothing short of a big deal. This is a big deal for many, many young parents. So I’m glad that we’re going to hit on these points.

John: (06:17)

Yeah. So I’m going to assume that if you haven’t had these important conversations about kind of goals and values and the trajectory of your family, that maybe you just pause the podcast right now, have that be your first action item, and then you would come back and listen to this, right. But let’s skip over that for now. And I want to get to the meat of this, Erica. So I have a framework when I’m in conversations with young families, we’re talking about college savings. I want them to know that the money to pay for tuition is a three-pronged approach. Okay. Here are the three prongs. The first bucket of money that paying for tuition can come from is a 529 college savings plan. Okay. The second bucket is what I call family money. And the third bucket is non-family money.

John: (07:04)

Okay. So, you know, you talked about UCI before, so whatever the total tuition is, you know, let’s say it’s under 80,000. When it’s all said and done, there’s actually paying for that liability or that expense of 80,000; it can come from three different buckets. It can come from a 529 college savings plan. It can come from some family money. And I’ll define that in just a second. And it can come from some non-family money and the percentages can change. It can be a third, a third, a third. It could be a half on one half on another. But the biggest point I want to make, as we’re just introducing this idea of a three-pronged approach, Erica, is to know that it takes a little bit of the stress off. You don’t have to do all of it today. Some of it happens later and some of it comes from some different buckets of money. So we’re going to start to put this framework here together in just a second, but those are the three big things that I want you to know about: tuition is going to be paid from a 529 college savings plan, a family money bucket and a non-family money bucket. 

Erica: (08:07)

You just gave me space to breathe right there. Like I’ll just take a breath. There’s three prongs. Let’s focus on that first one because the other two are easier to understand. So let’s start with that 529 college savings plan. 

John: (08:25)

I want to spend a little bit more time on this because the other two buckets are going to be self-explanatory. So hang with me here as we just do a little bit of education. So the 529 plan, a college savings account, the pros and cons of it. The benefit is if you put money in today, let’s say you put in a total of $10,000 just as an example, we’re in the state of California. So something to note, California doesn’t give you a deduction on putting that money in. So some for people, and that actually changed in the past, it was the case. And actually there’s something like almost 30 states do. So if you’re not in California, you’ve got to check with your grid, your state rules. So some states do this, but in California we don’t. So that 10,000 just comes from your checking and savings account.

John: (09:12)

It’s just cash. You put it in. There’s no tax deduction, but once you put it in, you can invest that money, you can grow in, let’s say the stock or bond market. And let’s just say later on it’s worth $20,000. Okay. So the 10,000 of growth is completely tax-free when you go to spend that money in the future. So long as it meets the criteria of spending, which are things like tuition and books and on-campus housing. So I think one of the biggest pros that I want to hit on, Erica, is that you’re eligible for tax-free growth if you invest inside a 529 plan.

John: (09:51)

Okay. All right.

John: (09:52)

So there comes a catch, just like everything in life. There’s a yin and yang to this. So in order to get that tax-free growth and to be able to spend it tax-free later, I mean, I mentioned this, but I just want to highlight, you actually can only spend on a really limited number of things. It’s very limiting, right? It’s tuition, it’s books, it’s on-campus housing. And let’s just compare and contrast. And I’ll think about my own college experience, Erica. I lived in a fraternity off campus and I did a study abroad and I bought a car to drive up to Seattle to go to school. And I ate out a lot because I was dating this girl that ended up becoming my wife. So think about all of the expenses that happen in college that are not tuition bucks or on-campus housing.

John: (10:45)

Right? So, I’ll zoom out here, but that’s part of why this is a three-pronged approach. It’s not all coming from your 529 plan. Some people are at a place where they don’t even want it because they don’t want any limiting factors, but just know the yin and yang is you get tax-free growth, but you can only spend it on a few limited things. And the last thing is, if let’s say that you were a superstar and somehow you ended up with a lot of money in your 529. And either your student didn’t use it all, or they didn’t even go to college, something like that, right? You get to pass this money on to your family bloodline, let’s say to another child that’s a sibling or some other family member.

John: (11:30)

You can check with your CPA about the nitty-gritty. And in the worst case scenario, you can take the money out later and spend it in retirement. There are taxes and a 10% penalty on the growth when it doesn’t go to education. It stinks, yes, but it’s not going to be the end of the world. So I just want people to know sometimes the concern that I’m hearing as well. What if we don’t use it all? And you’ve got two outs, you’ve got two back doors that you can go out of there. So that, in a nutshell, Erica, is my explanation of a 529.

Erica: (11:58)

That’s such a good base though, to start with, but I can understand why you don’t want to put all your eggs in one basket due to everything that you just mentioned. So it seems like there’s going to be a good even balance of all three. So let’s talk about the other two prongs. 

John: (12:15)

Okay. So this is my family money bucket, and there’s really two parts to this family money. So let’s fast forward. Let’s say now your child is 18. They’re going off to college. This family money bucket most realistically is going to come from either one of two places, which is your salary at that time. And somehow you’ll just free up space. And in the income that you’re receiving after your retirement and your tax deductions and your healthcare, and you get money deposited in your checking account, maybe you were focused more on sports or paying your mortgage or these other activities when your child was younger. And now you just end up directing whatever that cash flow is to paying toward the mortgage. So it’s you and your ongoing monthly paycheck; that’s going to fund some of these tuition costs, or it could just be whatever you have outside of retirement accounts.

John: (13:08)

Maybe you’ve done a good job saving and investing up until this point, you’re in your 50s or whatever. When your child is 18 and going to school, you might already have money outside of a retirement account in your investments. And maybe you take a small portion of that along with your paycheck to pay or cover the tuition costs. Or maybe even a last bucket, I guess, could be if you’ve got parents or grandparents, if you’re in a situation where you can do that, but this is family money buckets. And that’s money you worry about later, because as we talked about earlier, there’s only just so much money that comes in today. And I didn’t mention this point, but I think I’d want to reserve the 529 money for the money for a young family to do as soon as they can when their child is between ages one to 10, but then delay the other stuff and just know that once your child gets to 18, it’s going to come from your paycheck or from your regular investments savings at that time.

Erica: (14:07)

Yeah. Great. So that makes sense. So it sounds like for young families right now, the best thing to do is invest in that 529 college savings plan. And it sounds like for that second part, that family money part, there’s not a lot to do right now for this. That’s where you take your breath and you are able to kind of just know that family money is going to be invested once they do turn 18.

Erica: (14:30)

Great. Let’s talk about that third prong. 

John: (14:34)

So this is what I call non-family money. And this can take shape in a couple of forms. Again, this could take shape in something like a sports scholarship. It could be the child working a part-time job. It could be some financial aid or maybe even a grant. So there’s some external money that’s being provided. You know, so again, it’s a sports scholarship or it’s part-time work from your child and contributing to their own tuition, or it could be a financial aid, you know, alone or some type of a grant. So it’s money that’s coming from somewhere else. And so it’s pretty self-explanatory. You’ve got your 529, you’ve got your family money, and you’ve got the non-family money source. And again, you’re going to be paying tuition in some combination of these three.

Erica: (15:23)

Love that. I’d like to encourage the audience, if you guys do have kids that there are scholarships available. I wrote three essays and my first year of college was paid for just by writing three different essays. So just a little plug for the scholarship piece; it is so worth it to empower your kids to be able to try and contribute just even based on their intellect of everything that they’ve learned thus far in high school. So just a little plug in there to help assist with. 

John: (15:55)

That makes total sense. So, I want to give a quick example. I don’t want to do too much math because it’s going to be hard to hear this. So I want to try to simplify it as much as possible, but I just want to put this together in somewhat of a real-life example for somebody. Okay. So let me take that UCI tuition for a second and multiply by four. So let’s say the total tuition itself. So for tuition itself the cost is going to be, let’s say $55,000, and that doesn’t count food or maybe some extra travel or the car, but at least just tuition. So if we’re thinking, you could say, of those three buckets, I at least want to be able to pay for, let’s say, half coming from my 529 college plan. And if I’ve got a six-year-old, then I’ve got 12 years to invest money and grow it in order to then pay half of the tuition coming from the 529.

John: (16:49)

So my target, this is where I get a little bit nerdy and off the rails, Erica, but anyway, the financial calculator I’m using, my future value as 27,500, having that be 12 years away, we’re going to assume some stock market growth. I’m going to call it 6% just trying to find some number. And so what I really am trying to do is back into how much do I need today. What’s my financial commitment right now. And you know what that dollar amount is, Erica, it’s 13,000. So to say it one more time, $13,000 invested today over the next 12 years growing at 6% will end up being about 27,500, which means you would have grown about, let’s say almost 14, $15,000 that you’ve got in tax-free money. And so really the commitment today is to think, how do I cobble together 13,000?

John: (17:47)

Do I have it ready, and I just do a one-time check into a 529 plan? And that’s where you get your biggest bang for your buck. And then you can focus all of your other priorities for your emergency fund or your retirement account. You could cater your cash flow back in those other areas. Or maybe if you don’t have 13,000, you could say, let’s just break this up over a two-year, a three-year, or a four-year period. But I want to get that money in there as fast as possible. So let’s say I’m going to take the next three years, and I’m going to put money into this 529 so that it totals 13,000. And by that way, again, I’ll have almost half of all of the tuition and then I’m going to worry about the family money and the non-family money buckets as we get closer to that age 18.

Erica: (18:35)

That makes so much sense. And as a parent, it sounds so much better to say 13,000 versus that original 55,000. You know, it gives you a starting point and then you can decide based on circumstances, how to break that up and how to have it be more manageable for whatever your family is. And, you know, I guess one thing I like that I see there, it seems like what you’re saying is there’s just tons of flexibility and tons of options. And I think people it’s all going to be different, and also with that flexibility though, I could see how some families still might be wondering, okay, how do I put this all together? I know you’re talking about one kid here, but what if let’s say I have four kids and they’re all close in age and they may all be close to that college age. I would definitely want to see number one, how this actually all works, but I would definitely want someone guiding me every step of the way and coming alongside me and saying, is this right? Am I doing this right? You know, times two, three, four kids later, and that’s something someone like you, John, is someone that I would want by my side to just, you know, check my boxes with.

John: (19:46)

Yeah. Well, that’s a good call to action, Erica, I want to encourage. This is something that I do for all of my ongoing clients. It’s part of the financial planning process. It’s a way for me to hear about what their goals are. It’s a way for me to run a financial planning calculator and then throw things into Excel so that they know with absolute certainty to the best of our knowledge, how much they need to be contributing into the 529, doing that one prong, and then just working on the rest of their financial plan and not having to worry about it. So I want to encourage people, a call to action would be if you don’t have a financial planner, or if you just want to be able to ask some questions, I offer a free 40-minute consultation to analyze your situation and give you some unbiased advice. So you can go ahead and email me directly at thejohnchapmanshowatgmail.com. I’ll put my email in the show notes, thejohnchapmanshow@gmail.com. And I’d be more than happy to work through your situation.

Erica: (20:40)

I will definitely be giving you that phone call for that free consultation.

John: (20:43)

So I’ll recap. And then we can close. The picture is that tuition is going to be a three-pronged approach and might have different percentages. Maybe your family situation is such that you’ll have more coming from family money later on. If you’re going to have a high income or high salary later, or maybe you’ve got cash to be able to put into the 529 plan today, and you’ve got some parents or grandparents that can help you, or maybe your student is going to work part time or going to pursue sports scholarship. So there’s three avenues. And today, if you’ve got a child between age one and age 10, the only thing I want to encourage you to focus on is backing into a dollar amount that you could do into a 529. Let the market work for you so you can grow and compound this tax-free and then just sit back and relax and focus on your other priorities.

Erica: (21:35)

Love it. Thank you so much, John, for your knowledge. This is so refreshing to hear.

John: (21:41)

Yeah. Good. Thanks for joining me. And we’ll see you again next week.