Published March 27, 2014
If you thought tuition was expensive now, just wait.
Parents of newborns can expect a college degree to cost more than $300,000 when their children head off to school—and that’s if they go to an in-state public university.
According to Schwab Center for Financial Research, college costs have risen nearly 6% per year, which suggests that in 18 years, the price tag for an in-state public university for four years will cost about $302,000. A private school will cost almost double at $592,000. The anticipated costs assume a 6% average annual increase in tuition, fees, books, room and board, and other expenses, which has been the historical average year to year.
“If this trend continues, eventually they are going to get into the stratosphere that they look just so ridiculous,” says Rande Spiegelman, vice president of financial planning at Schwab Center for Financial Research.
With such a hefty bill to foot, Peter Catenacci, private wealth advisor with Ameriprise Financial, says parents are putting an increased emphasis on college savings when it comes to their own financial planning. “It’s not uncommon to have clients start saving before the child is born. We tell our families to calculate it, separate it, and automate [their college funds]. But at tuition’s current rate of increase, it’s getting harder to do.”
But parents shouldn’t feel obligated to pay for college, says Kathleen Grace, certified financial planner and managing director at United Capital. “Studies show there is a high correlation between paying for college and a decrease in kids’ GPA. It might actually improve a child’s performance if they take part in sharing the burden of the cost of college.”
While the price tag might staggering, experts say there are still ways for parents to take action:
Start Early. Take advantage of long-term compound growth, recommends Spiegelman.
“There is no guarantee that the stock market will go up every year, but when you have this long of a time horizon, there is going to be some growth." He recommends parents assess their risk tolerance and be a little more aggressive with equity investments early in a child’s life and then move to more safe options like bonds as high school graduation approaches.”
Set Up Tax-Advantaged Accounts. “If you are going to spend that much on schooling, you might as well get a tax break,” says Spiegelman.
There are a variety of tax-advantaged federal and state college-savings vehicles, including 529 plans and Coverdell Education Savings Accounts (ESA).
The 529 plans are a tax-advantaged investment account that nearly every state offers, which is why Grace recommends comparing different plans to find the best fit. The location of a plan does not have impact a child’s choice of school location.
“There is no limit on how much you can contribute to the account, but you are beholden to the investments of the states,” she says.
An ESA is a tax-advantaged investment account as long as the funds are used for educational purposes, which can include K-12 schooling. Multiple accounts can be created, but contributions cannot exceed $2,000 a year.
Don’t Choose College Over Retirement. There are loans, grants and scholarships available to help cover tuition needs; loans don’t exist for retirement.
“It’s hard to separate emotion from what makes sense, but you aren’t doing your children a favor bankrupting your own retirement for their college and having to depend on them later in life,” says Spiegelman.
Set an Earmark Precedent. The money often comes flowing in at the birth of a child, and Spiegelman advises setting aside a certain percentage of the funds for a college savings account.
“Start out with the understanding that 10-20% of all birthday funds and other checks from part-time work and other things goes into the fund. This will start a life-long discipline for saving and investing, something we all need.”
But don’t get too carried away with the savings goal, he says. “If you overdo it and make it punitive so they can never spend anything, that will turn them off and never want them to save.”
Start Pre-Paying Now. Many states offer prepaid tuition plans that allow parents to start saving for college at the current rates and redeem the credits in the future. If a child goes to school outside the state’s borders, the funds can be transferred, but not all schools are reciprocal, warns Grace.
“You can take the cash from the account, but there is a minimum interest rate the state will credit you each year if you take the cash elsewhere.”
Benchmark Often. Parents have about 18 years to save for college, and Catenacci recommends re-evaluating the plan and goal every few years to make any adjustments or to re-assess the goal.
“That is a long time; you might want to consider starting out with more risky investments and then tapering into more conservative options as freshmen year approaches.”
Create a Trust. A trust offers flexibility with unlimited investment choices and more control over when the assets are passed along to the beneficiary, according to Grace, but take note of the fees. “They can be expensive to administer, so they aren’t for everyone, but it allows the money to be taken out all at once or in payments.”