College Savings 101

College is now the second largest lifetime expense that you can expect to tackle, surpassed only by the cost of buying a house.

Generally speaking, tuition costs have increased 4-5% per year which is still just higher than the overall rate of inflation.

If you are a parent of a young child, or even if you are thinking about starting a family, saving for college should be part of the plan.

It is never too early to start saving and there are a number of questions parents wrestle with as they embark on the complex journey into college savings:

• How much do I save?
• Should I pay down my credit debt before saving for college?
• How do I balance saving for retirement and saving for college?
• Where do I store these funds?

There are a lot of decisions to make and you’ll want to set everything up correctly at the outset so that the money you invest isn’t wasted. This is where a financial planner can help.

One of the most important things for parents to do is called “defensive planning.”

Many people talk with great optimism about college being free by the time our children go to school, or that there will be guaranteed scholarships, or that grants and loans will be enough to ease the huge financial burden of a college education.

But we are not serving our child’s best interest by expecting these things to happen. It’s a dangerous mindset.

While scholarships, loans, and governmental reform are all nice possibilities, it is up to us as parents to lay that financial foundation for our kids.

In the 2021-2022 school year, only 26% of college expenses were paid for by grants and scholarships. (source: SallieMae.com)

That leaves a lot for parents and students to cover. I’m going to break down a few key concepts for you.

How much do I need to save?

This is a very personal question that requires a lot of discussion between parents.

I can give you some facts that may help with your decision making, but ultimately you will have to decide how much of your child’s education you would like to cover.

Some parents want to cover 100% of the cost of college, others would prefer to have their children work or manage their own loans.

No matter what you decide, you should be aware of what your children can expect to pay for college.

• If you have a child entering kindergarten this fall, that 5-year old will be shelling out close to $216,000 for a public in-state 4-year college education.
• If you’re looking into private school the price tag can go up to $445,000.
• If you have a 1-year old, sporting those adorable cheeks and just learning to walk, you can expect a college education to cost almost $274,000 in today’s dollars.
• For private school, don’t be surprised if the cost is closer to $540,000.

These calculations come from www.CollegeSavings.org. They represent the cost of fees, room, and board for a four-year education.

Given these numbers, you can see why it’s never too early to start saving.

Covering 100% of your one-year old’s college education would mean saving almost $600 per month if you start now. If you are just starting to save for your 5-year old, you’ll have to save a little more, close to $700 per month, because you have less time to save. This sounds unbelievably daunting, but there is help.

Where do I save?

There are enough options for college saving accounts to make your head spin, so let’s focus on explaining the main ones.

• Savings Account
• UTMA/UGMA Account
• 529 Account

Savings Account

The most basic strategy for saving for college is to open a savings account in your name or your child’s name and make scheduled contributions to that account. The deposits into this account will accrue interest and put you in a good position to start paying tuition when your child enters college.

But this approach does have some drawbacks. Most savings accounts these days offer fairly low interest rates, which will make it hard to keep pace with inflation..

UTMA/UGMA Account

Another option is to open a UTMA/UGMA account. UTMA stands for the Uniform Transfers to Minors Act and UGMA stands for The Uniform Gifts to Minors Act. An UTMA/UGMA account is a brokerage account you fund for minors.

You can buy mutual funds or other financial vehicles. This makes it a bit more flexible than a simple savings account.

Just be aware that control of the funds in this brokerage account will only ever change once: your child will gain control at the age of majority (18 or 21, depending on your state). There’s no way for funds to be transferred to another child if the initial beneficiary decides college isn’t the right fit.

The 529 Account

Both the savings account and the UTMA/UGMA account are simple, straightforward strategies.

They’re better than not saving anything, but with just a tiny bit more effort, you can make that money go further. Neither of these strategies are tax efficient.

Your best option for college savings is a 529 plan. The benefits of 529’s are huge and include

• tax free growth,
• possible state income tax deductions,
• portability (the ability transfer to another family member),
• flexible investment options,
• retaining control of the assets regardless of your child’s age,
• the ability to rollover leftover funds to a Roth IRA in the child’s name.

If you do decide on a 529 plan, there are a few extra decisions to make.

First, you’ll want to decide whether you want to hold a saving plan or a prepaid tuition plan. The savings plan operates similarly to an investment account where you are able to save money into various investment options. The prepaid tuition plan is basically purchasing tuition units at today’s price.

The question you want to ask yourself is whether you believe your investment choices (in a savings plan) will be able to outperform tuition increases (which a prepaid plan helps to guard against). The only way to know for sure is to use a crystal ball, but if you have one of those, you don’t need my help.

Another consideration when looking at these two types of plans are fees and custodians. Fees are built into savings plans.

If you don’t read the fine print, it can really eat into your returns.

The good news is that there are plenty of low-cost options out there. I’ve guided plenty of parents through this process and as with most things, once you’re familiar with the landscape, you know what to watch out for.

If you decide on a savings plan, you’ll need to choose a financial institution to house your account and select your investment options.

Alternatively, prepaid tuition plans are often housed with the state, so you’ll want to do research on the solvency of that state and whether or not you have access to that investment if you child decides to go to school elsewhere.

How do I save that much money?

Realistically, you saving for college means pulling several hundred dollars out of your paycheck each month.

Assuming you didn’t close this browser or lose your lunch after reading that, let’s talk about how to make this happen. And remember, you do not have to fund 100% of the costs. Grants, scholarships, work study, and student loans can all help to pay the bill, too.

First, close your eyes and try to hear “Eye of the Tiger” in the distance. You can do this.

The most obvious way to save for college is to set up an automatic savings plan that deducts a set amount of money from your checking account every month.

Think of it as a car or loan payment that happens each month, no matter what.

This may mean that you make some budget cuts elsewhere–perhaps it’s time to eat out less or cancel that subscription.

Giving up a $3/day cup of coffee can mean an additional $100/month in savings. This is a great place to start.

Set a challenge to save at least $100/month for the next six months. As your income increases and debt decreases, you can bump that amount.

Remember that as you get deeper into your career, your income will increase. The important piece right now is to establish a habit of saving.

Don’t be shy about sharing your goals and asking for help. Grandparents love to spoil their grandkids. A lot of the time that means ice cream and toys.

I suggest you get grandmas, grandpas, aunts, and uncles on board with your college saving strategy.

Instead of buying more dolls, trucks, and games for your child, have them put $25 into their 529. Birthdays and holidays are great times to request college savings instead of gifts.

Another way to deal with the toy surplus is to convert unused toys into a funding source. Do you have old toys or baby gear lying around? Sell it to a second-hand store and deposit the proceeds into your child’s 529. Every little bit helps.

Finally, make use of your own financial windfalls to fund your college savings accounts. If you get a bonus at work, if you inherit money, or if you receive a hefty tax return, then use it to beef up that 529 account.

Contributing 10%, 20%, or 30% of your windfall to college savings and it will pay off over time.

Make saving a priority

For most parents and students, the biggest concern about college is not whether they will graduate–it’s the burden of cost.

The sooner you commit to saving, the sooner it becomes a habit, and the more time your money will have to grow. And that’s how you’ll tackle that burden.

In most cases, your child’s education will be paid for by a combination of savings, loans, grants, student income, and scholarships.

But you only have control over one of these options: savings. Make it a priority.

Navigating the college landscape can be daunting. But once you know the landscape, you’re in a better position than most. Start making contributions today.