From Diapers to Dorm Room
The excitement of bringing a new baby boy, or girl, home from the hospital tends to obscure the need of starting to save as early as possible for large future financial goals. Especially the ever-rising cost of a college education.
The cost of living, as measured by the Consumer Price Index, has increased either not at all, or just a little bit, during the last few years. However, the cost of a college education, whether private or public school, has increased between 5% and 8% per year during this same period of time.
So we have two challenges to face regarding the current subject:
- the problem of getting us to focus on something that will not be a reality for eighteen more years, and
- the need to place our savings into some financial instrument that will at least keep up with the increasing cost of a college education.
I always tell my new clients… your behavior is more important than the behavior of the market. A minimum amount of financial discipline is necessary if you are to be a successful investor. The same holds true here.
Let’s assume that you and your family have the proper discipline to enable you to place a few dollars away monthly, even besides the additional costs you have recently incurred by having this new baby.
How Much Do I Need to Save?
The College Board indicates the average cost of tuition and fees range from around $9,400 annually for in-state students at public universities to more than $32,000 at private colleges. Multiply that by 5 years, the typical length of time it is now taking students to earn a bachelor’s degree, and you’re talking big money…and that doesn’t include housing, food and transportation. For that, figure another $10,000 per year.
Since we expect college costs to continue growing, let’s say you want to cover $50,000 in annual costs for four years in 18 years. If you save $500/month now, and are able to earn 5% on your money, that should get you pretty close.
Where Do I Put My Money?
There are a number of programs that you can place your savings into to keep that future student loan debt down to a reasonable level…
- 529 college savings plans
- Regular Savings Accounts
- Roth IRAs
- Coverdell Education Savings Accounts
- CDs and Savings Bonds
How Do College Savings Plans Work?
529 College Savings Plan
This plan lets you invest in mutual funds that carry the same risk/return profiles of other market based investment accounts. You set aside after-tax contributions that grow tax free, similar to a Roth IRA, but you have much higher contribution limits. These plans can then be spend on qualified educational expenses, such as tuition, room and board, and books. These plans are typically offered by a particular state, but it’s a good idea to check your home state’s plans first. You may be able to get a tax break.
Regular Savings Account
Most Americans use regular savings accounts to set aside money for college education. We’re talking little growth in this type of account, but these accounts offer the flexibility that allow you to spend the money on anything. This added flexibility can be a problem. You may find yourself tapping the education account for a vacation, or any other “must have” goodies that a slick commercial just convinced you that you can’t live without… and never replenish the funds in the future.
Roth IRA
You can use a tax-advantages Roth IRA as a combination retirement account and college savings vehicle…there is flexibility here. Your after-tax contributions grow tax free, and you have the ability to invest in an unrestricted array of investments. Withdrawals from a Roth are penalty free for qualified education expenses. If your child gets a number of scholarships, and doesn’t require the funds, your retirement savings are allowed to stay invested. However, contribution amounts are limited to annual maximums. Tapping this account for college can hinder your ability to stay on track for your retirement savings goals.
Cloverdell Education Savings Account
Coverdall Savings Accounts are like a 529 plan, but the contributions are limited to $2,000 per year. However, these funds can be used for all educational expenses, from K-12, college, and all the way through grad school.
CDs and Savings Bonds
CDs and Savings Bonds, during these days of low interest rates are an option for the very conservative investors. They offer almost no tax benefits, and low returns. If you have a child, you are probably not in the category of a very conservative investor and should consider one of the other options above.
Financial Guidance
As you explore these various options, you may wish to talk to an independent financial advisor. It helps to find a guide as you consider the following:
- How does savings for education fit into my financial life?
- What calculations do educational institutions use in determining financial aid eligibility?
- What investment options do I have based on my risk tolerance?
- What are the penalties for early withdrawal from the various programs?
Is College the Right Path?
Finally, is your child suited for college? I know of many successful individuals with a high-school education who started in a “blue collar” industry. These people learned how to provide good service, started their own company, and now are squarely in the top 3% of all income earners.