Written by: Corey Janoff
This post was originally published on our previous blog website on October 3, 2018 and has since not been revised and/or updated.
One of the last pieces of a well-rounded financial strategy is a college savings plan. This of course assumes you have children and want to pay for some of their future anticipated college expenses. If you don’t have kids, or don’t have any desire to pay for their education, then you can skip this one.
The reason I put college savings towards the end of the financial planning 101 syllabus is because it isn’t mandatory. There are ways to get a quality education without help from parents. Kids can go to an in-state public school to keep costs down. There are work-study programs. Scholarship opportunities. Student loans are generally an option as well. We can make college happen even if mom and dad aren’t paying for it.
There aren’t many alternative options for retirement other than to save up for it. So saving for retirement is mandatory. Most people won’t be able to support their life in retirement on Social Security alone. Making sure your income and family are well protected with proper insurances are extremely important, too. That is why those topics came before college savings.
That being said, I am a big fan of people wanting to pay for their children to go to college. The world needs educated people and graduating from college with a small country’s GDP worth of student loan debt isn’t a good way to start adult life.
Today we will dive into college savings. We’ll look at current and potential future college costs and discuss strategies for covering those anticipated expenses.
How Much College Do You Want to Pay For?
The first thing you need to ask yourself before beginning to sock away money for college is, “How much college do I want to pay for?” There is no right or wrong answer to this question. It could be a dollar amount. You may have a particular school in mind. It could be limited to undergraduate. It could include graduate school. Maybe you only want to pay half of the total cost. Whatever you want. First we need to establish a goal, then we can make a plan to reach that goal.
For example, if the goal is to pay for four years of in-state public school, that will require a drastically different savings rate than if you want to pay for any school in the country.
After running the numbers, if the amount you desire is out of reach, we can go back to the drawing board. We can revise other financial goals if paying for college is a high priority. Maybe it means working an extra five years before retirement is attainable. We may need to drop the goal of a vacation home, or private high school. Maybe we have to lower the goal for college if we don’t want to sacrifice other things.
So first, figure out how much college you would like to pay for and we can go from there.
What College Costs
Currently in 2018, the average cost of attendance for one year at an in-state public school is between $25,000 and $30,000 per year. Some schools are a little more, some are a little less. That includes tuition, housing, food, books, supplies, etc. The total cost of attendance.
The typical cost of attendance for a private school at the moment is around $70,000/year.
You can Google “University of _______ cost of attendance” to look up the cost of any school you want. It can be fun, or depressing, depending on the way you look at it.
Projecting future college costs is challenging, because we don’t know what the future will look like. If colleges continue to raise tuition rates the way they have over the last 10-20 years, we can expect college costs to more than double over the next 18 years. Not sure how many kids will be going to college in 20 years if that is the case, but that is a discussion for another day.
So if you have a newborn, plan on paying about $250,000 for four years of in-state public school and upwards of $500,000 for an elite private school.
Due to reductions in government funding, public schools have had to raise tuition rates faster than private schools, which don’t rely on the same government subsidies.
How Much to Save for College
The amount to save really varies by the goal. It makes sense to sit down with a financial advisor to run projections based on your children’s ages and the desired level of college you want to pay for. Contact one of us at Finity Group if you need help. #ShamelessPlug
However, I’ll give you some rough ballpark figures. If you have a newborn and want to pay for four years of in-state public school, start investing around $500/month. If you want to pay for four years of private school, start investing $1,000-1,200/month. If your children are older than zero years old, you need to save more to play catch-up.
No promises that will get you to your goal, but it will at least give you a good starting point. There are a lot of variables at work. We can’t predict future investment returns. It is important to review the strategy periodically to make sure you are still on track.
529 College Savings Accounts
The most popular vehicle at the moment for college savings is the 529 college savings account. This is basically a Roth IRA for college. You make after-tax deposits into the account. Any investment gains are tax-free. You can withdraw the money from the account tax-free as long as the money is used for college expenses.
If the money withdrawn isn’t used for college, you have to pay income taxes on any investment gains, plus a 10% penalty.
These accounts are super flexible. The limits on contributions are very high. Most plans will let you add money until the balance is around $400,000 currently. And that amount adjusts up over time to account for inflation.
You (the parent) are typically the account owner and name a beneficiary on the account (your child). You can change the beneficiary at any time to another child. If your kid gets a scholarship, most plans enable you to withdraw the equivalent value of the scholarship without penalty.
Bottom line, the government wants our children to go to college, so they make these accounts attractive for purpose of paying for college.
Many states offer state-sponsored 529 plans that provide state tax deductions on contributions. If you live in a state with state income taxes, it is smart to see if your state’s 529 plan has a tax incentive. If so, it probably makes sense to use a 529 plan from your state. However, you don’t have to use your own state’s plan. You can open an account wherever you choose.
I generally recommend people start with a 529 college savings plan. If the goal is to pay for more than an in-state public school, we will want to revisit the savings strategy after the 529 play accumulates a decent balance. Then, we often transition future contributions to a more flexible investment account that doesn’t penalize you if the money isn’t used for college.
Some parents plan to pay for any school in the country, but their kids end up staying in-state at a public school. Your wallet will thank your children in that scenario, but you will be kicking yourself if you have hundreds of thousands of dollars in 529 accounts that won’t all be used for college.
Other Ways to Save
If you are the person that wants to pay for any school in the country, you may be considering other vehicles in addition to the 529 college savings account.
The simplest option is setting up a regular brokerage account to invest in. These are the most flexible accounts out there. You can invest any amount you want. There are no limits on age, contributions, withdrawals, nothing. The downside is you have to pay capital gains taxes every year you realize a gain. Also, there is generally no asset protection with these accounts, unless they are owned by a trust for the benefit of your kids.
Another option is to open a custodial account for your child. Children aren’t allowed to be account holders until they are adults (either 18 or 21, depending on the state). So you can open an account in your child’s name, with you as the custodian on the account.
In this scenario, it is technically your child’s account. The first portion of investment gains are taxed at your child’s tax rate, which will be lower than yours. From an asset protection/estate planning standpoint, these are more attractive than the brokerage account in your name, because the account is in the kid’s name, not yours.
The catch with custodial accounts is, once the child becomes of age, the account is theirs. They can do what they want with it. Some parents don’t like the idea of their 18-year-old having access to piles of money. Now, you don’t have to ever tell your child that you set up an account in their name, but it’s something to be aware of.
There are plenty of other ways to invest money, but these are probably the most common if the goal is to pay for college.
Summary
If you have kids, don’t delay – start saving now! The sooner you get started, the easier it will be to achieve your goal. Open up a 529 plan in your state (if your state offers a tax incentive) and get that money to work!
Disclosures:
Any investment involves potential loss, including total loss of principal. Consult with an estate planning attorney for specific estate and asset protection laws in your state.
