For parents considering the future costs of college for their children, the question of how much to save for college is a common one. While the headlines scream about ever-increasing costs for higher education, for all but those with high incomes, saving for 100% of college for all of their children might be impossible.
Moreover, there is such a thing as saving too much for college. While the more common problem is not saving enough, it’s important to recognize that putting unlimited amounts of money into a 529 account isn’t necessarily the best idea either. So, how much to save for college? What’s responsible? What’s reasonable? What are some good milestone levels to consider? We examine these questions in this article.
How much does college cost?
In-state, public Universities are drastically cheaper than out-of-state and private schools. If your goal is to prevent your kids from having student loan debt, and saving multiple hundreds of thousands of dollars isn’t feasible, then sticking to the in-state, public schools is your best route. Note that there are many fantastic public schools, so there’s nothing to not be proud of in this realm.
According to collegeboard.org, average costs for the various types of colleges in 2018-19 were as follows (numbers are approximate):
- Public, Four-Year, In-State: Approx. $10,000 for tuition, approx. $15,000 for room, board and other life expenses. Or, $25,000 per year.
- Public, Four-Year, Out-of-State: Approx. $26,000 for tuition, approx. $15,000 for room, board and other life expenses. Or, $41,000 per year.
- Private, Four-Year: Approx. $36,000 for tuition, approx. $16,000 for room, board and other life expenses. Or, $52,000 per year.
Note that room, board and other lifestyle expenses are estimates and can obviously differ based on standard of living and other factors. Tuition costs are pretty good estimates. Also note that these numbers are primarily for undergraduate degree costs. Graduate programs can differ, especially with regards to tuition.
The above estimates show that private schools are double the public, in-state option, but in many cases, private schools can be even higher.
How much to save for college? Here are some possible options:
How much you can and are willing to save for your children’s education will vary depending on a large number of variables. Obviously, the more you save, the better. But, for families not able to fully foot the bill, here are some saving goals and strategies that many families implement as they seek to aid in the cost of education for their children.
- A fixed amount. One approach to the how much to save question might be to aim for a fixed amount. For instance, some families might aim to save $25,000 for each child by the time they reach college age. Accomplishing this is pretty straight forward. For instance, if you have a five-year old, stashing $100 a month into a 529 for the child will get you to the $25,000 mark if you assume a 6.75% rate of return.
- A percentage. Another approach is to aim for a percentage of the estimated costs. If your child will attend a public, four-year public school and you assume $25,000 per year in costs, you might aim to cover half the cost of college. That would come out to $12,500 x 4 = $50,000 in total. If you contribute $200 a month for a child starting at five years old, you should hit the $50,000 mark if you assume a 6.75% rate of return.
- The one-third rule. The one-third rule is another approach that some like to use as a guideline for saving for college. In this approach, you assume that college is funded from three sources: 1/3 of which comes from savings, 1/3 of which comes from current cash flow and 1/3 of which comes from student loans. This rule basically means that your goal is to save 33% of the estimated college costs for your children. It also means that you’re going to be able to cash flow 33% of the costs from your income at the time your kids are in college (obviously something to take a hard look at to see how realistic this might be). Lastly, your child will take on student loans for the remaining third.
- 100%. If your goal is to pay for your children’s college in its entirety, it doesn’t necessarily mean you need to pile up 100% of the estimated costs in savings. While likely a bulk will come from a 529 account (or other college savings account), some can come from cash flow during the time.
Regardless of how much you decide to save for college, starting sooner rather than later will make the task easier! Let compounding work in your favor, ideally tax-free in a 529 or other tax-sheltered account.
Types of College Savings Accounts
For the most part, when it comes to the types of college savings accounts, the conversation revolves around 529 Plans and Education Savings Accounts (also known as ESAs or Coverdell accounts). Both come with tax advantages which make them quite popular.
529 Plans are typically associated with a state, although you don’t have to reside in that state to participate in a particular plan. Anyone is eligible to open a 529 account, and there are no income limits for opening or contributing to the account.
529 accounts do not have an annual contribution limit in the traditional sense. Let me explain. First, 529 contributions are categorized as gifts for tax purposes. In 2019, the maximum an individual can gift to another individual tax free is $15,000 (up from $14,000 in 2018). As such, you can “gift” or contribute $15,000 to your child’s 529 account in a single year. That’s not all. Your spouse can also “gift” $15,000 as well. So, you can contribute $30,000 per year (assuming the gift exclusion remains at $15,000/yr) into your child’s 529 account.
It doesn’t end there. You can actually contribute more than that, but then it starts to count against your lifetime gift tax exemption amount. But at this point you might want to talk to an accountant.
There is one more dynamic to 529 contributing that lets you drop a chunk into a 529 account without getting into the lifetime gift tax exemption discussion. It’s called “superfunding” a 529. Essentially, you can contribute $75,000 in 2019 and have it treated as 5 years of gift exclusions. Rather than waiting to contribute $15,000 each year, you can contribute the entire 5-year amount right now. There are some tax forms associated with this, so make sure you discuss this with your accountant if you go this route. Regardless, the superfunding option is pretty interesting if you have the means to take advantage of it.
While there aren’t really annual contribution limits, there is a lifetime contribution limit that is equal to the estimated cost of education in your state. This can range from $200,000 to $500,000 so inquire about this amount when researching various plans.
The beauty of 529 accounts is that you don’t pay taxes on the gains of your investments as long as the proceeds are used for qualified educational expenses. Starting in 2018, this now even includes K-12 education expenses (typically private school).
Lastly, depending on your state, you can deduct 529 contributions from state taxes. Talk to your accountant about your particular situation to make sure you maximize this opportunity.
Education Savings Accounts (Coverdell accounts)
ESAs are also tax-advantage college savings accounts, but they have a few restrictions that 529 accounts do not.
First, ESAs are for couples with an adjusted gross income less than $220,000, or for individuals with an adjusted gross income less than $110,000. Contributions are limited to $2,000 per year until the beneficiary turns 18.
Moreover, the account must be liquidated by the age of 30. Like a 529, the beneficiary can change (or the account rolled over to a new ESA with a different beneficiary).
ESAs vs 529s
Now that you can also use a 529 account for K-12 education, there aren’t really any advantages for a Coverdell ESA account when compared to a 529. 529s have more flexibility, and you can contribute more per year.
Both accounts are not taxed on withdrawal if the proceeds are used for qualified educational expenses, and both accounts can be changed to different beneficiaries.
Tips For Moving The Needle On Your Education Savings
Like any form of savings or investing, the early contributions can feel like you’re getting nowhere fast. It’s true, compounding really kicks in when the balances are a bit higher. But pushing through this early slog is key to hitting your college savings goals. So what are some tips to kickstart this process?
- Take a short break from other investing, and jumpstart your 529 accounts. Ideally, you’re contributing into all investing and savings accounts at all times, but sometimes it’s acceptable to change things up for a short period of time to get a little momentum going. Emotions do come into play at times, and just getting to an initial savings goal – maybe as low as $1,000 – in your college savings accounts is enough to kickstart your process.
- Go on an extreme budget for a few months to kickstart the savings. Just like the above point, temporary measures can be used to get over the initial savings hump. Take a hatchet to your spending for a month or two and throw a few grand into your kids’ college savings accounts. Then, turn on the automated monthly contributions and you’re good to go.
- Skip a vacation and put that money into college savings instead. Boy, it’s hard to put off near term enjoyment in the name of long term gains, but that’s exactly what this is. Credit Donkey says that the average cost of a vacation for a family of four is just over $4,500. Skip this year’s big trip, and drop $2,250 into each of the two kids’ college savings accounts. There’s your seed money for future education expenses.
- Of course finding extra money is all about the difference in income and expenses. If you’re already slashed your budget, it might mean trying to work a second job or side hustle in the name of funding college savings. Even just a few hundred bucks a month is really impactful, and since it’s income above and beyond the typical financial situation, it won’t impact the rest of your life and investing.
Education saving strategies for larger families
College is expensive. The larger the family, the more expensive it is. Families with more than the average number of kids can have significant stress when it comes to attempting to get their kids through college without large levels of debt. Here are a few tips for large families who might have several kids in college at the same time.
When it comes to regular college savings for many kids, getting started early is huge. Also, since you can change the beneficiary on your 529 plans, it might make sense to focus on funding your oldest children. If your oldest gets scholarships and ends up not needing all of the money, then you can reallocate that money to the younger children.
Additionally, financial aid and scholarships can come into play for multiple children in the same family.
Standard financial aid options will factor in having multiple children in college at the same time. When a family fills out the Free Application for Federal Student Aid (FAFSA), they’ll be assigned an Expected Family Contribution (EFC). The EFC refers to the amount of money the family is expected to pay for their child’s education. Now this EFC number can get cut in half if a family has two children in college at the same time. For instance, if a family’s EFC is $30,000, then if there are two children in college, it would be $15,000 per child.
The EFC impacts what degree of financial aid might be available. If college costs $30,000 each, and your EFC is $30,000 and you have one child in college, then financial aid will likely be zero. If you have two children in college at $30,000 each, then the EFC would be $15,000 each. Then, it’s possible to pursue financial aid of $15,000 each (or $30,000 total). Note that there are other financial aid factors that might limit what you get (do your own research on it).
Lastly, one of the most impactful things you can do is be on top of your kids’ education during middle and high school years. By getting your kids on advanced tracks, you can easily knock out a large chunk of college for free during high school. Through IB programs, AP classes and dual enrollment opportunities, kids can graduate high school with up to the first two years of college already completed! Think about the cost savings there especially with several children!
It’s really important to note that this process does not start in high school. By getting ahead in middle school, your kids can begin knocking out high school level courses in middle school which will then enable them to knock out college level courses while in high school. This can pay off tremendously in many ways!
Education savings vs. Retirement savings
The education savings vs. retirement savings discussion is a popular debate topic in many financial forums. Many will be quick to point out that you can borrow money for education, but you can’t borrow money for retirement. It’s true of course, but it’s a bigger discussion than just the availability of debt.
While there’s no perfect answer, and it will ultimately be a personal decision, here are some approaches to consider:
- One approach is to make sure you’re maxing all tax-advantage retirement savings first. This means you need to be maxing out your 401(k) and IRA accounts every year before putting money into education savings. Not taking advantage of tax-advantage savings is a major mistake, so this approach has merit. What about individuals who don’t make enough money to max out their 401(k) and also still have money for education available? This is a tough question. Perhaps you split the money between 401(k) contributions and 529 contributions for your kids. Really the only mistake here is to forego retirement savings completely.
- Another approach is to use one of the “how much to save for college” approaches listed above as your starting point, then everything above and beyond that goes to retirement savings. So, if you decide you want to save a fixed amount, say $30,000, for each child’s education savings, then you can map out what your monthly contribution needs to be to get to that level. Then, everything above and beyond that goes to retirement. Again, just make sure you’re putting a decent amount of money into retirement. If you’re putting $400 into education each month, and $50 into retirement each month, then that’s probably not the best way to balance the two
Education savings vs. Paying off your mortgage
This discussion isn’t too dissimilar from the one above in which we discussed retirement savings vs. education savings. However, it has a few different wrinkles.
The reason that this debate comes up is because cash-flowing part of a child’s college expense is much easier if the mortgage is wiped out.
If you don’t have enough money saved to completely pay for your child’s college, it sure would be nice not to have a mortgage so you can more easily fund the college expenses in the moment out of regular income. Nobody disputes the advantage of not having a mortgage. The question is what’s the priority? Should extra money go into education savings or into paying down the mortgage?
Really this is no different from the typical question of whether to invest money into typical investing portfolios or to pay down the mortgage. And just like that discussion, there is no perfect answer. The true “return” on the money might be better by investing the money, but how do you quantify the peace of mind or the flexibility that comes with having your primary residence paid off? So, again, it’s a personal decision.
It probably makes sense to only contribute money towards your mortgage (that is, money that would otherwise be going into a college savings account) if you know that the mortgage will be completely gone by the time your children are college age. If you merely have a reduced balance on your mortgage, then your cash flow really hasn’t improved with respect to being able to fund college in the moment. Also, it’s important to have some savings for education, especially since it will grow tax free, so it’s not advisable to forego education savings completely in the name of wiping out your mortgage. If you can do both, great. If you can only do one, make sure you’re at least saving somewhat for college.
Interesting trends impacting higher education & their costs
The education space is going through quite a bit of transformation fueled by innovation and low-cost, internet-enabled distribution platforms. Ideally, this provides students will more opportunities at lower cost. The student loan crisis that many economists cite and the perceived decline of the cost-benefit ratio of the college degree has helped push companies and institutions to innovate in this space. This is likely to continue for the foreseeable future. Here are some interesting examples from recent years:
Georgia Tech’s Online Masters of Science degree in Computer Science (referred to as OMSCS) is an innovative program that offers students a graduate degree in computer science from a top 10 computer science department. The entire program is online which means you can live anywhere, and the cost is a fraction of many similar programs. To complete the 30 credits necessary for the degree, the estimated cost is $7,500 – $8,500 in total. Again, this is for a very valuable degree in a space that offers high compensation opportunities.
As a result of the success of the OMSCS program at Georgia Tech, other universities are following suit in offering online-based, low-cost masters degree programs.
It’s not just the programs themselves that are innovating. Purdue University is attempting to innovate in how college itself is paid for as well. Purdue recently became the first four-year institution in the country to offer an income-sharing type arrangement (sometimes referred to as an ISA) as an alternative to traditional student loans. At Purdue, they call it the “Back a Boiler” program.
An ISA allows students to have their college paid for, then they pay back the money after getting employment. Where this differs, however, from traditional student loans is that the amount they pay back will change and depend on the major and the amount of money they make after graduation. So, the less money a graduate makes, the less they pay back. And if you don’t work, you possibly don’t pay anything back.
It’s a structure that’s a little more common in vocational schools and coding schools. For instance, some coding schools will guarantee a certain type of job after graduation or your money back.
Regardless of the particulars of any given program, it’s nice to see institutions innovating and attempting different models from just saddling students with massive amounts of debt after graduating.
While the innovation in the education space may not factor into the question of how much to save for college today, hopefully they’ll be a net positive down the road when your kids are navigating their higher education options.