Saving for College

Saving for your children’s college education can be really challenging with so many unknown variables. Will your child get a scholarship? Do you want your child to attend a public school, which currently costs between $20,000 and $30,000 per year or a private school which can cost up to $70,000 per year? How much will college cost when your child is ready to start college and how much should you save? What is the best vehicle to use, a 529 plan, a brokerage account or another option? In this article we’ll simplify the confusion around saving for college and help you avoid being like the family:  

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What vehicle should you use?

Let’s start with what vehicle to use to save for college. I believe a 529 plan in the best vehicle to use to save for college. There are a number of pros including the fact that contributions to a 529 plan grow tax-free and can be withdrawn with no taxes or penalties, assuming the money is used for qualified expenses. These include tuition, room and board, books, and supplies for college such as a laptop. Additionally, 529 contributions are tax-deductible in 34 states and Washington D.C.1 Please check to see if your state is included.

There are also very high limits in terms of annual contributions and aggregate contributions. On an annual basis each parent can contribute up to $15,000 per year, and each parent can superfund $75,000 in one year if you don’t plan to make contributions for the next four years. Additionally, other family members can make contributions to the account as well. Each state sets their own contribution limit, ranging from $235,000 in Georgia and Mississippi to a high of $529,000 in California.2

Another little known benefit, is that if your child receives a scholarship, you can withdraw a matching amount from your 529 to be used any way you see fit without taxes or penalties. As a result, you don’t have to worry about your child getting a scholarship and you substantially over-saving for college. 529 plans can also be used to fund private K-12 education up to $10,000 per year. You can also change the beneficiary on a 529 plan to another family member, giving you added flexibility, or use the money to pay for an advanced degree for your child. Finally, while each college has their own rules in determine financial aid withdrawals from 529 used for qualified expenses are typically not reported as parent or child income.

The main drawback to using a 529 is the fact that the money needs to be used for qualified educational purposes or you will incur taxes and fees when withdrawing the money. Non-qualified distributions are subject to income tax and a 10% penalty on the earnings of your 529. As a result, you should make sure to have money saved in an emergency fund or a brokerage account, as a 529 plan is not a good source of funds for an emergency or other liquidity purposes. The other drawbacks are the fact that 529 plans typically have fewer investment options than a brokerage account and may charge higher fees depending on the investment option.

As you can see there are numerous benefits to saving for college with a 529 plan, and there are few disadvantages relative to saving for college with a brokerage account.

How much will college cost when my kids enter college?

While no one knows for sure how much college will cost in 10 or 20 years, there are a number of trends pointing to the fact that the cost of college will likely increase at a lower rate than it has in the past. This is a major relief for parents and guardians and directly contrast with the rapid increase in the cost of college over the past 40 years. We are now at an inflection point where the cost of going to college will likely plateau and could potentially decline in the next few years.

In fact the consumer price index for college tuition and fees declined 0.7% month over month in August, the largest decline since 1978! This is driven by several longer-term trends such as a large expected decrease in enrollment, recent decline in higher education inflation, major affordability challenges driven by the increase in student loans over the past 15 years, and the massive demand shock from COVID-19.

  • Weak demographics. From a demographic perspective, higher education enrollment is projected to decline rapidly after 2025 shown below due to the current distribution of the population in the U.S.3 This chart is based on some interesting research from Professor Nathan Grawe at Carlton College and implies much lower demand for college going forward.
    save for col1
  • Slowing higher education inflation. The rate of increase for tuition, fees, room and board has already been declining as shown in the below chart from College Board.4 As you can see the aggregate cost of tuition, fees and room and board has barely increased at all for Private Nonprofit and Public schools over the past few years. Of course, many well-known schools such as Ivy League schools and other prestigious private schools have greater pricing power and can increase their all-in cost at a higher rate. However, the overall trend is positive for those saving for college.
    save for col1
  • Exponential rise in student loans. Student loans have eclipsed auto loans, credit cards as the 2nd highest consumer debt category behind mortgage loans.  

Consumer debt chart

  • COVID-19 impacts. Last but not least, are the negative impacts that COVID-19 is having on higher education demand. These impacts include reduced demand from international students who pay the full sticker price, reduced demand from out of state students at public schools who pay higher tuition than in-state students, and the fact that many schools will only reopen remotely in the fall. Who wants to pay the full sticker price for an online-only offering? We're already seeing universities reduce tuition and room and board. Williams College just announced a 15% reduction in the cost to attend the prestigious school for the upcoming year. 

Conclusion

As a result of these trends, I expect increases in the cost of college to slow. In fact the cost of college may start declining over time due to the proliferation of remote learning, and weaker domestic and international demand. Personally, I use a 2% inflation rate for projecting the college inflation rate for my family's financial planning. So if the all-in cost is now $30,000 per year, in 16 years the cost should be around $41,000 per year.

 

Many financial advisors still use a 5% inflation rate, which projects to $65,000 per year and would lead us to substantially over saving for college. So when saving for college, I recommend projecting the cost of college to increase by 2-3% per year, to avoid oversaving. As I mentioned above the cost of college and fees declined in August by the largest amount since 1978. This is a great sign for parents and guadians saving for higher education! I will continue monitoring the higher education inflation rate and update this article as that inflation rate changes.Please use the calculator below to determine how much to save for college. Thanks for reading!

 

Check out this blog post for more detailed analysis on calculating how much to save for college

College Costs Calculator

Calculator Instructions

Enter ages as whole numbers.

Enter dollar amounts without the dollar sign. For example, for $10,000 you would enter 10,000.

Enter percentages as decimals. For example, for 2% enter 0.02.

Input values, click "Calculate" button for results.

On Site

 

 

1 https://www.finaid.org/savings/state529deductions.phtml

2 https://www.investopedia.com/articles/personal-finance/010616/529-plan-contribution-limits-2016.asp

3 https://people.carleton.edu/~ngrawe/HEDI.htm 4 https://research.collegeboard.org/trends/college-pricing/figures-tables/average-published-charges-sector-over-time


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