Just having had my daughter graduate from college this spring, I know the feeling of pride, sense of accomplishment, and downright relief that she didn’t have a younger sibling. 
Both my offspring now sport college diplomas — a process which started in the fall of 1998 and ended as mentioned above. Just over a decade of much hard work, test taking, studying, and calls to the Bank of Dad. The rule was simple — as long as your name was found on the Dean’s List, your standing with the Bank was outstanding. If not? You were on your own.
The last few years I’ve been asked at different times about the potential of real estate investing to fund the rising costs of a college degree. My answer has remained the same, it must, above all else, be a part of your Purposeful Plan. You can still use the tools I’ll lay out below, but having a Plan begin as close to your kids’ birth as possible will make things a lot easier, allowing things to materialize a lot more quickly. Also, it’s likely I’ll be advising you add a non-real estate tool.
Before starting — I’m completely against the government approach using the stale ‘tax shelter’ approach to saving for college tuition and costs. Suffice to say, I believe in my heart of hearts what I’m suggesting here is infinitely superior. Results differ, your mileage may vary. But instead of artificial limits, you’ll only face the limits you install, and financial reality.
You might consider a two pronged approach. Use your real estate investments in concert with a strategically designed EIUL — Equity Indexed Universal Life — an ‘investment grade’ insurance policy. Here’s how it might roll out.
The Real Estate Side
Whether you already own income property or are just beginning, you can use this strategy. Understand this: Diverting equity will necessarily bite into your retirement plan’s agenda. But we’re talking about a solid, priceless priority, right?
As you saw yesterday, time should be made your friend in this endeavor. That’s easily done by starting now. Remember — Sooner is better than later. Here’s your checklist of goals you want achieved by the end of high school.
1. Accumulate ass much unused depreciation as you can manage without meaningfully retarding your ultimate goals for retirement.
2. One or more smallish properties you can designate, not necessarily now, as set aside for college expenses.
3. An EIUL funded in each child’s name, when they’re as young as possible. How young? Before they come home from the hospital or when the insurance company allows it, whichever comes first. Again — Sooner is better than later.
4. A strategy of principal pay down on designated property(s) if specific property can indeed be designated, early on. Not crucial by any means, but nice if you can do it.
Here are your menu options.
Possibly the easiest is to buy a duplex before he/she can walk, and dedicate it to their college needs. That property will grow in value, (no really, we’ll have growth again) and you’ll eventually go down one of two paths. You’ll either take its cash flow and periodically pay down the loan ’till it’s paid off OR you’ll exchange it a time or three, turbo charging it’s capital growth and ability to generate annual tax shelter. (depreciation) It’s truly a judgment call which road to take, as there are so many factors out of your control with which you must deal. Again, individual circumstances will dictate clearly which way to go.
Either way, the end game has you with either a free and clear property worth several hundred grand, or you have multiple properties, all growing in equity, all generating tax sheltered income. They’re also, hopefully, spinning off loads of ‘storable’ depreciation for future use in the strategy. Which brings us to the mechanics of gaining access to the actual cash when you need it most.
If you acquired a $250,000 duplex this year for your two year old, you have about 15-16 years to make things work. If it appreciated a net 3.2% annually for 15 years, it’d be worth $400,000 — and would, of course be free of debt by then if you chose to eschew any exchanging. Lord knows what college might cost by then, but a 70% refinance would provide $280,000 minus loan costs — all of which would not be taxable. In fact, that refi isn’t considered a taxable event, period.
How’d it get debt free in 15 years? Not difficult. As the cash flow increases over the years, you keep applying an ever increasing amount to principal pay down. I’ve seen folks through cash flow alone, pay off loans in far less than 15 years. You just hafta be vigilant or it won’t happen.
The other way to look at this is to keep exchanging the designated property when the market says it’s to your benefit. This will have the affect of boosting your capital growth rate every several years — which almost always results in a much larger net equity than the first approach. You can still be applying cash flow throughout this process to the loan balances. This approach also increases the amount of unused depreciation available for the offset of any future capital gains you may opt to take for this purpose.
When it gets to be about a year before the apple of your eye is to get their high school diploma, you can, if you’ve ‘banked’ enough unused depreciation, sell one or more of the properties, offsetting the gain (and recapture) with said unused depreciation. Just did this for a rental recently, (one of our clients) and he successfully offset nearly $200,000 of gain and recapture. Sweet, eh? Of course, after 15, maybe even 18 years, you should be able to shelve much more than that amount. It depends upon your particular circumstances — especially you job income level.
The EIUL Side
Could this be any simpler? I’m not sure how. What you do is establish a policy for each child as early in their lives as possible. You contribute periodic payments from the time they are born, ’till they’re ready for Oxford. (Then you go all Willie Sutton on some bank, and… never mind.) As cash flow increases from both your job income(s) and the designated property(s) you apply a portion to the EIUL policy. Over a 15-18 year period this will develop into a very tidy sum — either a lump sum cash value, or a monthly income — 100% tax free — to fund or at least help fund college.
The EIUL approach by itself, if properly funded, could end up not only funding college, but providing living expenses too. Also, there’s virtually no limit to how much you can put in each year. Unlike government programs with silly restrictions everywhere ya look, the EIUL is paid with either after tax, tax free, or tax sheltered dollars. The income generated is tax free by definition, as would be the lump sum distribution if you went that way. No taxes or penalties to deal with at any turn.
Imagine how well you could incorporate these various strategies into a Purposeful Plan for your kids’ education AND their post college lives. If done long enough, and with diligence, it could also fund the purchase of their first home. Or, if the property happens to be local, it could BE their first home if you so desire. The options are many, and all on your/their menu — not the government’s.
Of course, there’s always the option of reverting the income to you after they’ve graduated college, and obtained their first job. Again, it’s your option. Do what makes sense.
15-18 years of healthy periodic payments into an EIUL has the potential to do two very important things.
First, it can result in $40-100,000 a year in tax free income — no kiddin’. Second, your child can then choose to ‘restart’ that one, or begin anew with their own money. Either way, you’ve not only funded a world class education, but you’ve launched them into the world with a potentially huge head start in life.
The best part? It only took a small slice of your pie to get it started, then it funded itself. Plus, you’re not gonna be worried as high school graduation comes closer and closer to reality. It becomes a joyous time of choosing where to go to school, and what makes the most sense for living arrangements — which by that time will be your option totally.
Now, as you might suspect, there will be nuances I’d apply to you that I wouldn’t to your friend Mike across the street. Duh. But the principles applied won’t change — funny how principles remain the same, isn’t it?
I have an EIUL expert I endorse without reservation, David Shafer, in Tampa. I was gonna link to him, but had second thoughts, as I didn’t want him blindsided. In the interest of full disclosure: Any business Dave does with folks I send him never results in any benefit to me financially, or any other way, with the exception of the knowledge you’ll be in great hands on that end. It’s been my policy with David, and he agrees completely, to keep what we do separate. If the best thing to do with a portion of my client’s capital is to make use of an EIUL, then that’s what we do. Case closed.
If you’d like to talk about this in detail, I’d love to answer your phone call or email. My cell is 619 889-7100, and you can email me through the Contact BawldGuy button up top. Have a superb weekend.
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