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Lesson 4e: College Education

Objective: Understand the cost of college and options on how to save for college.

Financial advisors say that a private college education in 15 years could cost over $100,000 a year (Wow!), so you better start saving now.  Financial advisors use this fear tactic to get clients to set up a Section 529 plan.  Before setting up a college plan, there are a few things to consider.

In particular, before setting up a college plan, you should have an emergency fund and retirement plan in place.  Your child can get a loan or scholarship for college, yet you will not be able to get a scholarship or loan for retirement.  In addition, there are additional ways to save for college which can bolster your child's appreciation for money that should be considered even if you can afford to pay 100% of your child's education. 

If you are ready to consider options for your child's college fund, here are a few points to help place the cost of college in perspective.

  • Current costs: Costs vary dramatically depending on whether the school is public or private.  For the 2004-05 school year, the cost is approximately $20,000 for private tuition and $5,000 for public tuition, plus $6,000 to $7,000 for room and board.
  • Future costs: College costs will increase, and this is how financial advisors catch your attention.  Yet, your salary will also increase along with all other goods and services, due to inflation.  For example:
3% Increase
5% Increase
7% Increase
Current Cost
5 years
10 years
15 years
20 years

    Advisors typically use a 5-7% increase for tuition because this has been the typical increase over the past 10 years, and these higher rates catch your attention.  Yet, there is no way to be certain that long term growth in college costs will continue to be 5-7% compared to the more typical inflation estimate of 3-4%.  In particular, with an increase in online education, costs may actually decrease because the infrastructure costs (costs of buildings) are less with online schools which may control the overall cost increase. 

  • Actual cash cost: Even though costs have gone up, the net cost (total cost less scholarships and loans) as a percentage of salary has been relatively stable. See College Board, figure 9.
  • Cost of loans: USA Today reported that the average college undergraduate student loan has increased from $12,100 to $19,130, up nearly 58% in the past decade.  However, 1/2 of the increase is related to basic inflation which is also reflected in starting salaries of college graduates.  The news focuses on these costs because they can raise eyebrows with a 58% increase.  What they do not factor in is that students will have higher salaries than they did 10 years ago to help offset the increase in loans.
  • College enrollment: Even though you may want your child to go to college, your child may have other plans.  Approximately 60% of recent high school graduates enroll in college.

So yes, the cost of college has gone up but not as dramatically as some would have you think when you reflect student aid and adjust for inflation.  Yet, to minimize the amount of student loans needed, creating a savings plan can ease the burden of paying for college. 

You have many different options in saving for your child's education.   Key items to consider in planning your savings goal:

  • Type of plan : A summary of different plans can be found at TIAA-CREF, key components to consider are:
    • Who controls the assets - parents or children - in Coverdell accounts, children own the assets, so they can choose to take the money and buy a motorcycle instead of using it for college.  In addition, keeping assets in the parents' name compared to the child's name will help with student aid.
    • Ability to use funds for other schools or purposes - Some schools allow you to lock in tuition at today's rates, yet what happens if you child decides to go to a different school?
    • Many financial experts recommend a national Section 529 plan even though these plans are set to expire in 2010 (they expect Congress to extend the use of these plans).
  • Amount needed : College costs vary greatly from $5,000 at a local public school (excluding room and board) to $40,000+ at an Ivy League school.  Factoring in college aid, the amount can be significantly less.
    • You may want to target saving for all or part of a basic in-state education (e.g. $10,000 to $15,000 factoring in room and board increasing at a rate slightly higher than normal inflation e.g. 5% or 6%).  If your child goes to a private or out-of-state school, then you will need to find other ways to cover the extra costs (e.g., scholarship, income from work, loans, etc.).  You can estimate what you will need to save at CCH college calculator or Smartmoney college calculator.
  • Cost of savings plan: Many financial institutions charge an extra fee for 529 plans, and as a result, the tax advantage benefit may be eliminated by the cost of the plan.  The key is to look for plans with small fees like Fidelity or Vanguard and avoid plans that charge over 0.75% administration fees. Fees higher than this will offset most if not all the tax advantages of a Section 529 plan (especially if you factor in the fact that you will save more the closer your child gets to college age, giving you a shorter period of tax-free interest to begin with).
  • Other sources: Most parents want to start saving for college when their child is born.  This is the time when parents tend to be cashed-strapped the most, especially if they just bought a bigger house for their expanding family.  So you may want to wait and partially rely on your income later in life when you have the highest disposable income (especially if your income is expected to increase when a stay-at-home parent rejoins the workforce).
  • Child's motivation level: How motivated is your child to help pay for college (e.g., your children helping apply for college scholarships, getting summer internships/jobs or graduating in 4 years versus 5 years)?  The burden shouldn't fall entirely on the parents. 
Financial Topic : Planning - College Education
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