For the sake of making it easy to reference my FPU summary posts, I’ve listed the links below. It took me longer than I though to write this series but think they’ll be a good resource for those who’ve attended FPU. I know I’ll be referring to them in the future.

I want to reiterate that these summaries are not meant to be a substitute for attending FPU. Not only are they not comprehensive (I couldn’t cover every little detail), but half of the value of attending FPU is the act of physically going and taking the time out each week for 3 months to think about and work on your finances. In fact, even though my wife and I already know this content, we’ve considered attending again simply for the discipline of reviewing all aspects of our financial life. The classes are also very motivational. The fact is, I’ll probably be conducting a round of FPU at our local church so I’ll get to participate again, this time as a moderator. I’m excited at the prospect of introducing others to Dave Ramsey and helping them reach their financial goals.

So without further ado, here are the links to each FPU summary post.

Financial Peace University Part 1
Financial Peace University Part 2 – Understanding Insurance
Financial Peace University Part 3 – Retirement and College Planning
Financial Peace University Part 4 – How to be a smart consumer
Financial Peace University Part 5 – Tips on buying and selling real estate
Financial Peace University Part 6 – Increasing your income through career development
Financial Peace University Part 7 – Collection practices and the spiritual side of managing finances

In this final installment of the Financial Peace University summary, I’ll cover credit collection practices and will briefly address the spiritual side of managing your finances. This series of summaries about FPU has taken much longer to complete than I originally anticipated. The information was so good I couldn’t pack it into just a couple of posts. I’m glad we’re ending with lucky post #7.

Credit collection practices

In week 12 of Financial Peace Universtiy, Dave Ramsey addresses credit collection practices and how to create a plan to deal with creditors. This is not an area I’m familiar with so I can’t add much of my own opinion. Hopefully those of you dealing with creditors will find this information useful. If you’ve had experience dealing with creditors, please post your experience and any advice in the comments.

It’s better not to go into bankruptcy, but rather to create a plan.

Dave’s first piece of advice is that you’re better off dealing with creditors than going into bankruptcy. If you have a clear plan and communicate that to your creditors, you can make it through the experience.

Collectors are not professionals. Don’t let them manipulate you into thinking they are.

Dave mentions that the average turnover for a collections agent is 90 days. It’s literally a revolving door. This helps you put things in perspective about who you’re talking to. It’s not an intimidating professional in a suit and tie, but more likely some tween in a tee shirt and jeans who won’t even be around next month.

A collector agent’s first rule is to evoke emotion (fear, anger).

Collection agents use scare tactics to manipulate you by evoking anger and fear. If they can get you to react strongly, you’re more likely to take action. Beware – This will lead you to make non-logical decisions that won’t be in your best interest. For example, in the heat of the moment, you may reason “I’ll pay this off to show you and get you off my back.”

Take care of the “four walls” before paying creditors.

Take care of your necessities before paying creditors. Dave defines necessities as the “four walls” – food, shelter, clothing, and transportation. In a previous session Dave tells a story about when he had creditors coming after him. He and his wife ordered their budget according to needs and drew a line on the paper after the “four walls.” When the creditor called, Dave told them “I’m sorry, you’re below the line.” The creditor asked “well how do I get above the line?” Dave replied “You be nice next time you call.”

Creditors have rules dictating how they can act. Don’t let them break those rules.

In 1977 the government passed the Federal Fair Debt Collection Practices Act dictating how collectors can behave.

Here are some things to look for:

• Creditors can only call between 8 AM and 9 PM.
• You can send a certified letter to your creditor with a return receipt stating they are not allowed to call you at work. If they do so, they will then be violating federal law.
• They can’t use gestapo tactics. Dave tells a story about a collection agent who sat in the debtor’s driveway and threatened him when we got home. If the collection agency is using such tactics you can send a cease and desist order. But be warned, doing so could trigger a lawsuit.
• No collector can confescate your bank account without suing you. If they say they can, they are lying. However, they can do this with student loans because there is such a high default rate.

Create a plan for paying your bills.

The main way to deal with collection agencies is to create a plan and communicate it to the agencies.

If you can’t pay all your bills:

1. Take care of your needs first
2. Create a Pro-rata plan in which you pay your creditors as a percentage of how much debt you have with that company. For example, if you owe one creditor 25% of your total debt and another 75% of your total debt and you have $100 a month to pay down debt, you would send the first creditor $25 and the second $75.
3. Send a cover letter with copy of your budget every month along with your payment.

Communication is key in dealing with creditors. If they see you’re making progress and have a clear plan, they’ll be much more confident that they’ll get paid and will be less likely to pester you.

The number one catalyst of filing bankruptcy is pressure from collection agencies. If you communicate excessively they probably won’t sue (although they could). A proactive approach is the best.

Settling debt for less than the full amount.

If you don’t have enough to pay a debt you can ask for “settlement in full.” This means you offer to pay less than the full amount you owe immediately if they will consider the debt paid. If they agree, make sure you have a written agreement. This is a less desirable approach since you should ideally pay whole debt (you do owe it). It also will show as a gray mark on your credit report (which is better than showing as a black mark). Also, if you receive a settlement in full, the amount of the debt you don’t pay off is taxable income.

Managing your credit report.

Here are some useful tidbits to help you manage your credit reports.

• Financial accounts are taken off your credit report every 7 years from last report. Bad debts stay on your credit report because they continue to be reported. The sooner you pay them off the sooner they will be removed.
• Keep track of your credit report. 50% of people have errors on their credit report. 37% have major errors that can make it hard to get a job or loan. Check your credit report once a year. You are entitled by law to one free credit report a year from each of the three major credit reporting companies: Experian, Equifax, and TransUnion. Get your free credit reports at AnnualCreditReport.com.
• The credit bureau is required to remove inaccuracies within 30 days of you reporting it unless they prove the inaccuracy is correct. If they don’t remove the inaccuracy you can have them take off the entire file (Dave wasn’t clear on this point but it sounded like you could actually have the entire financial account removed from the record).
• You can contact the credit bureaus to prevent you from receiving pre-screened marketing offers from financial institutions. You can call each company and follow up with certified mail to each of 3 credit bureaus. If you request a block by phone it lasts for two years. If you request a block in writing, it lasts forever.

The spiritual side of managing your finances.

Dave wraps up Financial Peace University in week 13 by talking about the spiritual aspects of managing money.
I know many people give Dave a lot of flack for talking about spiritual matters, but it’s hard to deny the impact of having a charitable mindset. I personally have had many positive experiences giving funds for charitable causes and have seen miraculous results. If nothing else, the idea of sharing your wealth is healthy from a psychological perspective.

Dave points out that we shouldn’t just try to gain more money for the purpose of holding on to it. Money is just a small piece of life and isn’t the source of happiness. By using money to help others, we can keep money in its proper place and maintain a healthy attitude towards material gain.

Giving money to worthy causes helps our relationships and increases our wealth.

Dave advocates giving a portion of your income to charitable causes. This helps you release your tight hold on money and helps it flow to those who need it most, including to yourself in times of need.

We are happiest and most fulfilled when giving and serving. Giving is:

1. A reminder that the lord owns all. We are just stewards.
2. Praise and worship. We show our attitude towards God when we share our money with others. It’s a form of praise.
3. Spiritual warfare. Giving freely of your wealth can spiritually protects you against both spiritual and temporal harm.

Dave offers the following guidelines for sharing your wealth.

1. Give 10% of your income
2. Give off top. Budget your charitable giving first. Don’t wait until you’ve budgeted all your categories or you won’t have anything left.
3. Give offerings in addition to tithes. When possible give above and beyond the 10% tithing.
4. Never give with the motive of receiving in return. If you give with the wrong motive, you won’t receive the corresponding blessings
5. Financial peace is about understanding. By putting money in the proper place and perspective, you can obtain financial peace. It’s not about how much money you make or how much “stuff” you have.

In week 11 of Financial Peace University, Dave Ramsey talks about the income side of the equation. Up until now, Dave has primarily talked about managing the expense side of the financial equation. What people often don’t really think much about when managing their finances is that an increase in income of $100 is the same as a decrease in expenses of $100. Sometimes the fact is that you just need to make more money to make ends meet. Easier said than done, right? Well, yes and no. Sometimes it’s easier than you think to increase your income. In many cases it may be as simple as walking in to your boss and asking for a raise or a bonus.

Dave provides advice about not only making more money but also about how to get more joy and fulfillment from your career. Here are the highlights from this week’s session. I’ve thrown in my own comments and points for good measure.

• Be prepared to change jobs…and grow your career – 50 years ago people would work for one company their whole life. Now the average career lasts 3.2 years. The downside is you shouldn’t expect to stay in one place for too long. The upside is you shouldn’t expect to stay in place for too long. Changing jobs isn’t the stigma it once was but that’s a good thing – it makes it easier for you to change roles and accelerate your career development. Rather than being stuck in the same job or role forever, you can experiment with different roles and areas of responsibility until you find one that suits you.
• Determine what contribution you want to make in life and seek to make it – Being introspective to determine your life’s goals is a good thing. You shouldn’t choose a job or career solely based on money but rather on making your unique contribution. You will end up much happier and fulfilled.

  Dave tells about an experiment where researchers hired a group of people to dig a hole. At the end of the day, they were instructed to fill the hole back up. The next day they were told they would be paid more money for doing the same job, yet not everyone showed up. After several days of hole digging, the crowd of workers dwindled even though they were paid progressively more. Because they felt like they were doing meaningless work, they were dissatisfied regardless of the income.

• Make sure your job lines up with your values – This is an extension of the previous point. If you do work that violates your values, you will inevitably be miserable. For example, working in a bar is not ideal if drinking is against your values.
• Your job is not your life – While you should seek meaningful employment, it’s also important to realize your job is not your life and doesn’t define you as a person. You have many roles in life as a family member, friend, member of the community, etc. Your job is just one piece of your life.
• Do you have a job, career, or vocation? – I liked the way Dave defined each of these terms. A job “J-O-B” is daily activity that produces income. A career is a line of work, but not necessarily a calling. A Vocation is a calling, purpose, or destiny. Dave says “If your vocation is something you love, you’re on vacation for the rest of your life.
• Your personal style will help you choose your career better than your education – Dave points out that 15% of success in a job comes from skills whereas 85% comes from personality, ambition, enthusiasm, and attitude. You can gain most of the skills you need on the job. In fact, most people don’t even go into a field related to their major in college.
• When finding a job, be yourself – your best self – When sending resumes and interviewing for jobs, don’t try to be something you’re not. People will almost always see through your act. Instead be your best self. Finding a job is essentially a process of marketing yourself – so highlight your best points and accomplishments but be honest.
• Networking is key to finding a job – This is good solid advice. Only 15% of jobs are covered in newspaper classifieds. The best jobs aren’t even posted and must be found through networking. When looking for a job, be sure to tell everyone that you’re looking and what you’re looking for. Be specific. Jobs may come from the most unexpected contacts…even from a friend of a friend.
• 3 steps to landing your dream job – Dave provides some specific action steps to help you land your dream job. Basically you make a list of companies you’re interested in and contact them three times.
  1. Send an introduction letter stating that you’re interested in the job and that you’ll be contacting them and sending them a resume
  2. Send your resume with a cover letter stating why you’re interested in the specific job and why you’re the right person for the job.
  3. Call the company (ideally the person responsible for hiring) a couple days later to follow up and make sure they received everything

  Most people don’t make the consistent effort that these steps require. Even though they’re simple, by doing them you will stand out amongst other candidates as a person ready to take initiative.

• In your resume, don’t just list where you’ve been, but rather what you’ve done and how it applies to the job – A resume is not just a list of places you’ve worked but should rather list what you accomplished at your previous jobs. If you can show anything quantifiable, that’s even better. And if you can show how your accomplishments will help you in the job you’re applying for, you’ve hit a home run.
• If necessary, take a temporary job to clear the log jam – Oftentimes, you’re in a financial bind and just need an extra boost to clear the metaphorical log jam – maybe you just need to pay off that final debt or to finish saving for a vacation. If that’s the case, a temporary job may be just the thing. It’s amazing how quickly you can get a job as a pizza delivery person; and how quickly you can earn a few hundred or thousand extra dollars.

  Taking on a temporary job:

  1. Cleans up little bills
  2. Reduces debt with gazelle intensity
  3. Helps you save for stuff or vacations
  4. Helps you build up some lump sum savings (emergency fund or your children’s college education)

• Start a home based business – The possibilities of starting a home-based (or cottage industry) business are endless. And the good part is, you can do something you love. 45% of homes have a home-based business. Dave tells the story of a lady who placed an ad in the back of a magazine selling her homemade pecan pie recipe. She literally made thousands of dollars selling her recipe.
• Build a home-based business with time, patience and consistency – This is my input on starting a home-based business. I’m convinced that anyone can do it given enough time, patience and consistency. Don’t expect it to be an overnight success. Set aside time every week to work on a business. Just start with your best idea without worrying too much if it’s the right one. If you put in consistent time and effort, over time you can make your business grow.

In part four of the Financial Peace University I’ll cover week 9 titled “Buyer Beware.”

Week 9 Buyer Beware

Dave Ramsey talks about how marketing affects behavior and subsequently debt levels. Some of the information about how companies use marketing to entice consumers is interesting but I somewhat question the usefulness on a practical level. Simply knowing the tactics companies are using doesn’t mean you’ll be immune to their effect.

Beware of marketing tactics

Here are some examples Dave uses:

• The number of daily marketing impressions the average person is exposed to has increased from 500 in 1971 to over 4,000 today. I believe it. In today’s multimedia culture, particularly with the internet, we are exposed almost constantly.
• More than half the GDP consists of consumption spending.
• Dave outlines the ways we’re sold to, including
1. Personal selling – Sales materials are increasingly customized and personal. By using database technologies, companies often have much information on potential buyers and are able to target individual needs.
2. Financing – Many businesses provide lines of credit or other forms of financing. In fact, some businesses make more money from financing than they do on actual consumer goods sales. I shouldn’t even need to mention that it’s a mistake to buy consumer goods with borrowed money.
3. Repetition – This one is self explanatory. This one is self explanatory.
4. Product positioning – Ever noticed the ice cold drinks displayed prominently in the store on a blistering hot day? Large companies are very savvy and do extensive research to determine the best way to position products in a store.

Again, I found this information useful but not incredibly useful or practical. There are many ways companies market that Dave left out. In fact, I currently run the marketing for a multi-million dollar internet company and am very familiar with many additional sophisticated marketing techniques. For example, a techniques called means-end laddering identifies the high-level personal benefits and values of consumers and emotionally ties the products features to them. Statistical clustering allows marketers to profile certain market segments in great detail and can effectively predict how certain segments will react to products. Conjoint analysis allows marketers to predict how much more a consumer will pay for a product given a tweak in the features of the product (e.g. gel vs. paste consistency in toothpaste).

Although marketers use these techniques, they are not necessarily bad. While they can be used for evil purposes, for the most part they can actually benefit the consumer. Using such tools, companies can create products that more fully meet consumer preferences. As a result, the consumer’s quality of living increases over time.

How to save on big purchases

On the more practical side, Dave gives a few very good tips for spending less, particularly on large purchases.

1. Wait over night before making a large purchase (being defined as $300 to $1,000 depending on how much money you make). Many of the large, multi-hundred dollar purchases people make are surprisingly impulse purchases. This happens particularly when people receive large lump sums of money such as a bonus. They go on a shopping spree and before they know it have spent the money on things they may not care that much about. The simple act of waiting overnight to make the purchase will deter most frivolous impulse purchases. Once the excitement of the moment has worn off, your brain actually thinks about it and realizes you’d rather spend the money elsewhere or even save it.
2. Understand the difference between needs and wants. You don’t need the wide screen 60″ LCD TV. You might really, really, really want it, but you don’t need it. Your needs are food, shelter, clothing, and transportation.
3. Never buy anything you don’t understand. If the sales person can’t explain it in terms you understand, don’t buy it. Buying things you don’t understand inevitably will cause you to buy something that doesn’t really fit your needs.
4. Consider the opportunity costs (what else could you do with the money). Opportunity cost is an economic term defined as the most valuable foregone alternative. Put in layman’s terms, what else could you do with your money? For example, if you spend $1,000 on the TV, what will you not be able to buy with that $1,000? Maybe there’s something else on your list of wants that you’d rather have even more. I frequently experience regret from buying several smaller items and realizing later that I could have saved that money to buy a bigger item that I want significantly more than the smaller ones.
5. Seek the counsel of your spouse. As painful as it may be, two minds are better, or at least more reasonable, than one. Unless you are spending personal money, you should consult your spouse on all major purchases anyway. A spouse can offer a different perspective and can often bring to your attention other uses for the funds or other alternatives that may meet your needs at a lower cost.

Part 3 of the FPU overview covers week 8 of Financial Peace University – Retirement and College Planning. This post will apply to Dave Ramsey’s baby steps #4 and 5. Baby step #4 is: Invest 15% of your income into tax-favored investments (typically Roth IRAs or 401ks). Baby step #5 is : College funding. It is assumed that you won’t start doing either of these steps until you have saved a full emergency fund (3-6 months of expenses) and paid off all your debt except your house.

If you’re joining this series late and want to catch up see the links below for parts 1 and 2:
FPU Overview Part 1
FPU Overview Part 2

Why should I have an emergency fund and no debt before investing for retirement and college?

Dave is very strict about having an emergency fund and paying off debt before investing for retirement. He even says you shouldn’t put money in a 401K with a match (which is when your company matches a portion of what you invest – it’s basically free money). When we attended Financial Peace University we were already contributing to a 401K with a match and decided not to follow his advice on this point. It would have been much more disruptive to stop contributing. We would have lost the match and had to wait until the enrollment period to start up again.

Saving an emergency fund before saving for retirement

I’m aware that many people disagree with Dave’s advice on this point because if you wait to invest, you lose some of the advantages of compound growth. I personally can see it both ways. I tend to agree that you should have an emergency fund first. Otherwise you may have to dip into your retirement savings to cover emergencies and invoke severe tax penalties. If you take funds out of a 401K or IRA before retirement you pay excessively high taxes which would be like kicking you when you’re already down.

Paying off debt before saving for retirement

Having all your debt paid off before saving for retirement is a more tricky argument. Frankly, Dave doesn’t address it much. As far as I can tell, the main reason for doing so is focus. The more you focus ALL available money on paying off debt the more momentum you’ll get. There’s a strong psychological benefit to seeing your debt paid off at an accelerated rate.

From a math perspective, you can argue either way. If the interest rate on your debt is higher than the interest rate you’d get investing (typically about 10-12% if you invest in mutual funds), you’re better off paying down your debt. Otherwise, you’re better off investing. Having said that, even if you think you could earn 10-12% on a mutual fund, you’re not necessarily guaranteed that rate of return whereas you are guaranteed the return by paying off your debt.

In the end, I don’t think it matters much whether you pay off debt first before investing or not. I would do whichever gives you the most motivation and peace.

What investment vehicles should I use to invest for retirement?

During the session, Dave explains many savings vehicles in great detail including IRAs, Roth IRAs, SEPs, 403Bs, 457s, and 401Ks. Rather than explain them all, I’ll hit the highlights. Here is Dave’s basic strategy for investing for retirement:

1. If your company’s 401K offers a match, invest just enough to take advantage of the full match.
2. Next invest in Roth IRAs until you reach your maximum contribution.
3. If you still have money left to invest, go back and invest in company plans (401Ks) or SEPs.

Within IRAs, Roth IRAs and 401Ks, you can choose what stocks, bonds, and mutual funds you want to invest in. For Dave’s advice on how to allocate funds see Financial Peace University Summary Part 1

Now let’s briefly explain the differnt retirement vehicles. Keep in mind that these are the most basic definitions. I’ve included links with more information for those interested.

Types of retirement investment vehicles

IRA

IRA stands for Individual Retirement Account (or Arrangement). An IRA allows you to invest money pre-tax and allows your investment to grow tax free. You then only pay taxes when you withdraw the money at retirement. The IRA itself is really a stock, bond, mutual fund, or other investment that is simply designated as an “IRA.” Even real estate can be used for an IRA. As Dave puts it, the IRA is just a “coat” to keep your investment protected from taxes.

To invest in an IRA you have to have a earned income in that year. In 2007 you can invest up to $4,000 per person if you’re 49 or younger or $5,000 if you’re 50 or older.

Wikipedia entry about IRAs

Roth IRA

A Roth IRA is similar to a regular IRA with one huge difference – with a Roth IRA you invest money post-tax but then your investment grows tax free and you can withdraw it at retirement tax free. In very basic terms, you would typically choose a Roth IRA if you think your income at retirement will exceed your current income. Otherwise, a traditional IRA would make more sense.

Wikipedia entry about Roth IRAs

401K

A 401K acts like an IRA in that you invest money pre-tax and your savings grows tax free. You are then taxed when you withdraw the funds. One of the main differences between an IRA and 401K is simply that a 401K is offered specifically through your employer.

With a 401K you are also more limited in your investment options. The company running your 401K usually provides a pre-selected set mutual funds to choose from.

One benefit of 401Ks is that some employers offer a match – they will match a portion of the amount you save. For example, my current employer matches 100% of my contribution up to 4% of my income and then 50% of my contribution from 4 to 6% of my income. Just to make the math simple, if I made $100,000 and saved 6% of my income, rather than ending up with $6,000 invested I’d end up with $11,000 ($6,000 contribution plus a $5,000 match). It’s basically free money and you should definitely take advantage of a matching program if your employer offers one.

Dave points out some people don’t use the 401K if there is not a match. That’s a mistake. Even though they don’t offer a match you still get the great tax benefits and should still contribute.

The maximum contribution to a 401K for 2007 is $15,500.

Wikipedia entry about 401Ks

403B

A 403B is essentially the same as a 401K but is offered by hospitals, schools, and non-profit organizations rather than corporations.

Wikipedia entry about 403Bs

SEP

Simplified Employee Pension (SEP) plans provide a way for small business owners to provide retirement plans to themselves and their employees. When an employee participates in an SEP, they essentially create an IRA, which in this case is known as an SEP-IRA. SEP-IRAs have the same tax implications as traditional IRAs. Employees can contribute up to 25% of their income. Self employed individuals can contribute up to 18.6% of their net profit.

Wikipedia entry about SEPs

457

The 457 allows you to defer your compensation. Instead of receiving income now and being taxed on it now, you can receive it and be taxed on it later. Rather than receiving the income, you can invest it. Essentially this acts similarly to a 401K. I’m personally not familiar with 457s and Dave didn’t recommend them. Use your company’s 401K instead.

Standard Thrift Plan for government employees

For federal government employees you have the standard thrift plan. Dave recommends putting 40% in C fund (common stock plan, 17% return over 10 years. Modeled after S&P index), 40% in S fund (small company fund [aggressive growth], modeled after Barclays index, averaged 14% return over 10 years), and 20% in I fund (International, 8-9% return, modeled after the Barclays EAFE index).

Rolling out funds

401Ks, 403Bs, and 457s are all offered by your employer. The good news is, you can transfer or “roll out” these investments when you leave the company. You can also roll over IRA accounts. Dave recommends rolling out funds whenever you have the option because you have more flexibility in a non-employer plan – you can invest the funds exactly how you want rather than being forced to choose from a limited selection. 401Ks and IRAs can typically only be rolled when you leave the company. However, 403Bs can be rolled at any time.

When you roll funds, be sure to do a direct transfer rather than bringing the money home first. If you have them cut you a check they have to hold 20% of the money until you decide where to invest it. Then if you don’t reinvest you have taxes of about 40% on those funds.

When you roll out funds, you need to decide if you want to roll them to an IRA or Roth IRA. Dave recommends you roll them to an IRA unless you meet the criteria below, in which case you should roll them to a Roth IRA:
1. You will have saved $700,000 by the age of 65.
2. You can pay your taxes separately out-of-pocket. For example, if you roll $10,000 to a Roth IRA, you have to pay taxes on the $10,000 immediately. If you don’t have the funds to pay the taxes right now, you can roll funds in chunks as you have money to pay the taxes.
3. You have less than $100,000 in income the year of the roll. Rules state that you can’t roll to a Roth IRA if you have $100,000 or more in income that year.

Borrowing against 401K – DON’T DO IT!

Some people ask about borrowing money against your 401K. On the surface it seems like a good idea – you can pay yourself interest rather than the bank. However, you should never borrow against your 401K because there are severe risks. Here are 3 reasons why you shouldn’t borrow against your 401K.

1. You unplug yourself from the stock-like returns.
2. You might leave or be fired. If you leave, that loan is due in full within 60 days or it’s considered an early withdraw.
3. If you die, you are deemed to have left the company and your spouse has to pay back the loan.

Saving for Education

For the seemingly rare few who already have a full emergency fund, all debt paid off, and are saving 15% of your income for retirement, you can move on to baby step #5: Funding your child’s college education. I think this step is appropriately placed in relation to the other goals. You need to make sure you take care of your own financial situation, including retirement, before worrying about your kids’ educations. If you don’t, they will have to take care of you financially when you retire. Of course, I paid for almost all my college education and therefore am biased towards having children pay their own way and/or get scholarships. Regardless of your stance, Dave’s placement of this baby step is prudent and appropriate.

Use ESAs and UTMA/UGMAs to save for your child’s education

Dave’s advice is pretty straight forward – save for your child’s education first using an ESA, then using an UTMA/UGMA if you max out the ESA.

Education Savings Accounts (ESA)

An ESA is essentially an IRA for education rather than retirement.
A parent sets up an ESA for his/her child and acts as the custodian. Contributions to an ESA grow tax-exempt. If the child uses the funds for qualified educational expenses, those distributions can be used tax free. You can make a maximum of $2,000 in contributions each year. You have have an income under $110,000 if filing as a single or $220,000 for married couples to use an ESA.

Investopedia has a nice overview of ESAs

Uniform Transfer to Minors Act (UTMA/UGMA)

If you max out your ESA contributions or you make too much money to contribute to an ESA you can use an UTMA. The Uniform Transfer to Minors Act allows you to open a Mutual Fund account in the name of the child. The parent is custodian of the account until the child is 18. The downside (or upside if you’re the child) is that funds in an UTMA don’t have to be used for education. The child can use funds how they want when they turn 21.

Wikipedia entry about UTMAs

Don’t use 529 plans or use life insurance for college savings

Dave recommends staying away from 529 plans which force you to put the money into pre-defined mutual funds that don’t provide a good enough return. Age-based 529 plans invest the funds more conservatively as the child reaches 18 and give you no control. They are too conservative.

Dave also recommends avoiding the following:

• Using life insurance policies (such as the Gerber Life Insurance policy) to save for college
• Use savings bonds or zero-coupon bonds for college investing
• Using pre-paid college tuition

Conclusion

Please recognize that the above descriptions are not meant to be comprehensive by any means. Dave Ramsey goes into quite a bit more detail in Financial Peace University and even his descriptions are not comprehensive. Hopefully this will give you a base line for understanding your investment options and spur you on to learn more. Stay tuned for part 4.

Other Resources

Retirement Savings or Debt Reduction: Which is the Top Priority? [Get Rich Slowly]
Retirement Savings Or Debt Repayment: Which Is More Important? [The Simple Dollar]
3 Common 401(k) Mistakes [The Consumerist]