This article is an excerpt from the Shortform book guide to "The Total Money Makeover" by Dave Ramsey. Shortform has the world's best summaries and analyses of books you should be reading.
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What is the Dave Ramsey 529 vs ESA analysis? What does Ramsey recommend for saving for college?
According to Dave Ramsey, 529 vs ESA is a matter of choice. Both of these options are good for saving for college and definitely better than debt.
Read on for more information about Dave Ramsey, 529 vs ESA, and college expenses.
Dave Ramsey: 529 vs ESA
The most effective vehicles for saving for college are an ESA (Educational Savings Account), which is like an IRA for education, and a state 529 plan. So, for Dave Ramsey, 529 vs ESA is your choice.
College tuition increases faster than inflation, at about 8% versus 4%, so when you save for college, you need to factor in tuition inflation. There are tuition prepayment plans, but as mentioned earlier, they just break even with inflation. Savings bonds and whole life insurance for babies generate returns of only 2% to 5%. A savings account generates even less.
You can do much better with an ESA funded in a growth-stock mutual fund—like an IRA, it will grow tax-free. Here’s how it compares to a prepaid tuition plan:
- If you invest $2,000 a year from your child’s birth through age 18 in a prepaid plan, you’d have $72,000 for tuition.
- An ESA in mutual funds returning 12% would generate $126,000 tax-free. It would take only $166.67 a month to save $2,000 a year, and in 18 years, you’d have enough to send your child to an expensive college. But you could still probably afford a typical college if you started investing when the child turned 8.
If an ESA won’t be enough, start there and also consider a state 529 plan, which also allows you to invest money tax-free for your child’s education.
There are several types of 529 plans—stay away from the “life phase” plans (poor returns) and “fixed portfolio” plans (too restrictive). The best option is a “flexible” plan that allows you to move your investment within a family of funds to get better performance.
By saving for college, you break the cycle of debt for your children.
If you started your Total Money Makeover later in life and therefore didn’t save for college, there are other options, though you have to be creative.
First, you can save on costs if your child starts at a cheaper school, like a community college, that’s also nearby so the child can live at home. Otherwise, look for cheap housing instead of luxury student apartments.
Steps a student can take include:
- Getting a job with a company that helps pay college tuition—UPS is an example
- Going into the military or National Guard
- Promising to work in an underserved area to get help with costs for law or medicine study
- Getting scholarships: Many scholarships go unclaimed each year, yet small grants from many community organizations can add up. For example, one enterprising student obtained a database, applied for 1,000 scholarships, and received 30, which paid $38,000
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- The 7 steps to achieving financial stability (you'll love #7)
- A fool-proof plan for becoming debt-free
- How myths about debt and money are crippling your financial health