CNBC’s Jim Cramer cringed when he read a study that said students who graduate with no debt end up being worth more than classmates with outstanding loans.
“For any of you who are parents or are thinking about becoming parents, let me just tell you right now that there are very few things you can do for your children that are better than paying for as much of their college education as you can afford,” the “Mad Money” host said.
In the hierarchy of needs, first comes saving for retirement. Then saving for college, even if your child is a toddler, Cramer said.
The best way to save for college is with a 529 plan. Rules vary by state, but there are certain aspects that are standard across the country.
There are two types of 529 plans: one uses the account to hedge against tuition inflation by buying tuition credits at today’s prices that can be used in the future. However, that is not the type of plan that Cramer recommends.
He recommended the second option, a 529 savings plan.
Much to Cramer’s dismay, most 529 plans in general do not allow investors to manage their own portfolios. They are required to pick between a mixes of different mutual funds.
The “Mad Money” host always wants investors to have control over their assets; however, he is willing to deal with this one flaw. He recommended choosing a low-cost fund that mirrors the market, such as the S&P 500 or Vanguard Total Market Fund.
Due to federal gift tax laws, single investors can only contribute $14,000 a year, or $28,000 if you’re married and file taxes jointly. Grandparents can contribute to the plan, as well, and can even start a 529 plan with your child as the beneficiary. Still, Cramer thinks it is better for a parent to do it.
In the event that you or the grandparents have a large lump sum of money, one of the most attractive things about a 529 plan is that you can front-load up to five years in contributions and avoid the federal gift tax. That works as long as no checks are written to the beneficiary within five years.
That’s a boatload of money and a lot of savings. A single parent or grandparent could potentially invest $70,000 into the 529, right off the bat.
“The key here, though, is that you want to get that money into your kid’s 529 as early as possible,” Cramer says. “That’s because the greatness of these plans is all about the power of compounding.”
Since investors do not pay taxes in the 529, the more time money has to sit in the account, the more opportunity money has to perform. If you invest in a low-cost index fund that mirrors the market, that account will make an average of 8 percent per year.
If stocks perform like they have historically, that means you could double your investment in approximately nine years.
Granted, most people cannot front-load a 529 like this. However, Cramer thinks it is important to remember that front-loading as much as possible is the best strategy.
What if your kid doesn’t go to college? Another perk to a 529 is that any money that is unused can be transferred to another relative. You can also withdraw the money, though that will be subject to taxes on any gains and a 10 percent penalty.
“After you’ve made enough for retirement contributions for the year, putting money in a 529 college savings plan should be the next item on your agenda. It’s the best way to protect your kids from the crushing burden of student loan debt,” Cramer said.