Lesson
4e: College Education
Objective: Understand
the cost of college and options on how to save for college.
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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 |
$20,000
|
$20,000
|
$20,000
|
| 5 years |
$23,185
|
$25,526
|
$28,051
|
| 10 years |
$26,878
|
$32,578
|
$39,343
|
| 15 years |
$31,159
|
$41,579
|
$55,180
|
| 20 years |
$36,122
|
$53,066
|
$77,393
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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.
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