Saving For College 101
Updated May 2021
Being in a profession that is no stranger to student debt, college savings became a priority when we were expecting our first child, as I think it should for many of those that expect their children to attend college.
First, let me hit you with some scary statistics. Not for shock factor, but simply to let you know what the actual numbers look like right now in 2021 according to collegedata.com.
Cost of college tuition and fees:
Private colleges: $37,650/year
Public college (in-state residents): $10,560/year
Public college (out of state residents): $27,020/year
Cost of room and board:
Private colleges: $13,120/year
Public colleges: $11,620/year
Then there are other expenses, such as books/supplies, transportation, and personal expenses.
As you can see, if you want to attend a four year college, the average price can range from approximately $20,000-$50,000 per year. Multiply these numbers by four, and that’s how much one can expect to pay for a four year college degree. The estimated costs of attending the most expensive colleges in this country are $70,000+ per year. Compare this to the most recent United States median household income, which was $68,703.
Remember, we are talking about the cost of college NOW. As you can guess, college tuition costs have far outstripped inflation and wages. If you are expecting to have children or have young children at home, you can expect that these numbers will continue to rise. I have absolutely no idea how this is sustainable, but this is the trend that’s happening right now.
What if your little one decides that he/she wants to attend veterinary school? Or any other postgraduate program of study? Well, you’re looking at a lot more $$$.
How can anyone afford this? Yes, there are those families who can actually pay out of pocket due to their high income status. But for the vast majority of families, they will need to look at other sources. Outside of family contributions, you are looking at two options: scholarships/grants and loans. Yes, these will decrease the amount that you need to pay up front, but even if you were expected to pay just half of actual college expenses, you can imagine how burdensome this will be for many families.
I remember filling out the FAFSA form for college, not quite grasping the concept of how much all of this was going to cost. I also remember the financial hardship that my parents experienced during my first semester. I had younger siblings still living at home, and my family’s expected contribution was not in line with reality. They did everything they could on their end by also taking out parent loans, and I did my part by working during school and over the summers to help defray costs. I was completely on my own by the time I went to veterinary school, and all of this schooling resulted in six figure debt. Having gone through this experience, I can confidently say that planning for educational expenses is always a good idea.
Mr. RLDVM and I decided that once our children were born, we were going to start saving college ASAP. We both saw the value of education and realize the sacrifices our respective parents made in order to provide us with our educational opportunities. We are now in the position to do the same for our children, and due to our level of financial literacy and careful planning, we are on track to pay for college with less stress and anxiety.
A QUICK NOTE BEFORE SAVING FOR COLLEGE
Before diving headfirst into saving for college, look at your overall financial situation. Namely, are you saving for retirement by maxing out your 401(k) (or equivalent retirement accounts) and contributing to your IRAs? If you are not saving for retirement, then prioritize this first before saving for college. Although not the ideal situation, there is always the option to take out loans for educational costs. There is no such option for retirement. You can read about my reasons why I want you to start thinking about retirement NOW by clicking here. I am pretty certain that your kids would rather take out student loans than stress about financially supporting you during your retirement.
Other financial obligations to consider is having an emergency fund (usually 3-6 months of expenses) and having a spending plan in place so that you can figure out how much you can actually set aside for college savings.
That being said, if you feel like you are ready to start saving for college, start ASAP. The earlier you start this process, the more time you will have to see the beauty of compounding as you watch your account value grow over the years.
THE 529 PLAN
The most popular savings vehicle for college are 529 plans. These are tax-advantaged plans that you will typically see sponsored by states. There are also some educational institutions that offer 529 plans. Why are they so popular? The reason they’re so popular is because the money that’s put into the plan grows tax-free, and you can take the money out tax-free. It’s basically a “retirement account” for college.
There are 2 different categories of 529 plans.
- Pre-paid plan: Essentially, you pay for college up front in today’s dollars. This is great from a financial standpoint because as mentioned beforehand, it’s almost guaranteed that tuition will continue to rise significantly. However, you are usually tied to either one educational institution or a limited group of educational institutions. If you’re positive that your little one will attend State U and see no reason to attend any other college, you can consider this.
- Savings plan: This is more commonly used compared to the pre-paid plan. In this scenario, you are investing your money in mutual funds. You are then free to use this money for any qualified educational expense, which currently includes college tuition, room and board, books and supplies, and computers.
WHICH 529 PLAN?
There are quite a number of 529 plans out there, so it will take some homework to figure out which one to sign up for.
First, you’ll want to research the 529 plans that are available in your state. This is because they may offer a tax deduction on your contributions. Any way you can lower your taxes is always worth looking into.
Next, you can start researching other state plans. Yes, you can sign up for any 529 plan, regardless if you are an actual resident of that state. When looking at plans, you will want to pay close attention to the types of investments they offer and their fees and expenses.
- Types of investments: Many plans will offer age based options that will invest more heavily in stocks while the child is young, then will automatically switch over to more fixed income (bonds) investments as the child gets closer to college age. You can typically choose your level of risk (conservative, moderate, aggressive). This is very similar to target retirement funds that will automatically change your asset allocation based on how close you’re getting to your retirement. There will also be some static options that are not based on age for those that like to pick their own investments. You should also check out the fund managers that are in charge of the underlying investments. Seeing fund managers like Vanguard, Schwab, and Fidelity can give you piece of mind that the investments are being managed by reputable companies.
- Fees and expenses: Usually these fees include account management fees and the fees associated with the underlying investments (expense ratios). The lower the number, the better.
In a nutshell, if you are comfortable with their investment options and the expense ratios are relatively low, then you’ve found a good plan.
What about direct-sold 529’s versus advisor-sold 529’s? If you are comfortable opening up an account on your own, direct-sold is the best way to go. Advisor-sold 529’s rely on a broker, and you will be paying extra broker fees. The only situation where you should be getting an advisor-sold 529 is if you already have a financial advisor. Just understand that you will be paying more for this option due to extra fees. Even if you have a financial advisor, you can still absolutely go with direct-sold 529’s and set it up yourself. Many 529 plans offer quite a bit of information on their website to help you get started.
Lastly, compare your in-state plan(s) with out of state plans. Here is a good website to start your research.
What if you get a great tax benefit from your in-state plan, but you like the investment options and lower fees of an out of state plan? If you have the means to do so, you can sign up for more than one plan for the same beneficiary. You will have to make some calculations to see if this works for you, but if the state plan has decent investment options and the fees/expenses aren’t excessive, fund the state plan just enough to get the tax benefit, then put the rest in the out of state plan.
529 PLANS- PROS
- As mentioned earlier, these plans grow tax free and you can withdraw the money tax free. Your state plan may offer a tax deduction as well.
- You can have more than one 529 account for the same beneficiary. You just have to make sure that you don’t incur the gift tax if you contribute more than $15,000 annually (per individual, per beneficiary).
- You can change the beneficiary to other family members. If you have multiple children, this can be helpful as one child may need more money for college or postgraduate education than another. Many plans have broad descriptions of “family member,” so you are not just limited to your immediate family members. You can even use the 529 for yourself if you decide to go back to school.
- There is no income cap, so wealthy families are certainly taking advantage of this option!
- The money is no longer restricted to just college. The tax bill that was passed in December 2017 now allows money in a 529 plan to be used for K-12 private education (tuition only). You will have to check with your individual plan to see if they will allow the funds to be used in this manner.
529 PLANS- CONS
- You can only use the money for qualified educational expenses (tuition, room and board, books and supplies, and student loans with a limit of $10k). As of now, travel, transportation costs and health insurance are not considered qualified educational expenses. You will still need to pay for college related costs, but it won’t be as massive as trying to also pay for tuition and room/board.
- If you have to withdraw money for other, non-educational purposes, you will be subject to a 10% penalty and and you will be taxed on any earnings.
- Your child will possibly qualify for less financial aid.
For me, the advantages far outweigh the disadvantages. There is a reason that 529 plans are so popular, and hopefully more and more families will be encouraged to save for college using these plans.
OTHER WAYS TO SAVE FOR COLLEGE
- Coverdell Educational Savings Account (ESA): Like 529 plans, Coverdell ESAs offer tax free growth and tax free withdrawals. They also used to offer the advantage of covering K-12 educational expenses, but as mentioned earlier, Congress now allows 529 plans to also cover K-12 private education. The biggest difference is that you are capped at contributing $2,000/year per child, whereas you can save significantly more in a 529 plan. There is also an income cap; your eligibility to contribute to a Coverdell ESA starts phasing out if you have a modified adjusted income of $95,000 for single filers and $190,000 for married filers (tax year 2017).
- UTMA (Uniform Transfer to Minors Act) and UGMA (Uniform Gift to Minors Act): These are considered custodial accounts. Essentially, these are protected savings accounts for minors, so it is not limited to just educational expenses. Little Junior will reach a certain age (depending on which state you live in- usually between the ages of 18-21) and will now have complete and total access to the funds in these custodial accounts. You cannot tell Junior that he must spend this money on college tuition, or any other college related expenses for that matter. He has the freedom to spend the money however he’d like. I think you’d have to have a very mature, trustworthy college aged kid to feel comfortable with this arrangement. Some other negatives are that you must report income from this account on the child’s tax return, the accounts are non-transferable, and they will count against financial aid eligibility.
Bottom line: If you are intent on saving for college, 529 plans offer the greatest benefits. Coverdell ESA’s are also a good vehicle that you can use as long as you’re ok with the contribution cap and you are within income eligibility requirements. UTMA and UGMA custodial accounts have too many negatives when using them as strictly college savings accounts.
Have you started saving for college? Did you find the process difficult? If you are currently using your 529 for your college aged child, please share your experience!
Nice article! fwiw, many of our doctor clients’s children have Coverdell ESAs. We set up an UTMA account for the child, gift the child $2k/year, and let the child “make” the contribution. It’s perfectly legal. Since 529s are limited to only $10k/yr for grades K-12, the ESA is a nice way to save for private grade/high school. We typically plan to use the money beginning in 8th grade to give the account time to grow.
Thanks- did not know about this option! Good to see that UTMA’s can be used in a practical way for education expenses!
I am glad to see you mention getting your emergency fund and retirement plans funded first. I would also argue sufficient insurance coverage (disability, umbrella) should be taken care of, too. How do you feel about saving in a 529 when you still have student loans? Seems best to me to take care of your own education before worrying about your child’s. You may also get a better return which is guaranteed, depending on your loan rate and tax bracket.
Personally, we started saving in a 529 while still paying off student loans. Investing for future expenses and paying off debt can be done simultaneously, as long as you’re hitting your own personal goals and targets. For those who are on track to have their loans forgiven, there is no incentive to pay any more than the minimum payment anyway, so they should theoretically have enough disposable income to invest in a 529 if they so choose.