Saving With Purpose: The College Savings Fund

This is the second post in a series called Saving With Purpose: Living a More Intentional Financial Life. In this series, I plan to highlight a number of specific savings goals my family has identified we would like to achieve over the next few decades.

Before having kids, both my wife and I agreed we wanted to help our children with their education. My own experience struggling to finish school after taking on student loans, and then charging tuition and books to a credit card, strengthened my position. Like all parents, I wanted better for my own kids.

However, we also want to balance our desire for them to have it easier, our own retirement plan, and my wish for them to learn the value of hard work. One of the mistakes many parents make is that so overload college savings they hurt their own financial plans.

I’ve known parents who saved $200,000 dollars in mutual funds for their kids’ college education, but have zilch in their own retirement plans, a big mortgage payment left from their refinance, and a host of other debts. I will always advise to take care of your own financial plans first, and college savings second. After all, there are no scholarships for retirement.

Having said that, because we are maxing out our retirement plans (more on that in an upcoming post in the series), we hope to also fund our kids’ college needs – at least a large percentage of them. Unfortunately, we got a late start because we put off college savings while paying off our debts. The good news is that we have more to save without debt payments. The bad news it will take some hefty savings contributions to cover college expenses for our oldest, now 10 years-old.

Determining Future College Costs

Hope you are sitting down for this section. College costs are ridiculously expensive, and getting more expensive every year as the rate of tuition costs increases at a faster rate than inflation (between 5%-8% per year). Let’s run some numbers at the website CollegeBoard.com, which has a pretty good calculator.

Assumptions

  • Annual college costs, in today’s dollars: $19,388 (4-year public, in-state)
  • College cost inflation rate: 5%
  • Expected years of attendance: 4
  • Percent of costs you plan to cover from savings: 100%

The inputs above yield the following future college costs for both kids:

  • Tuition costs per year in 8 years: $28,645
  • Tuition costs per year in 13 years: $36,550

For those keeping score at home, that works out to $123,463 and $157,574 (keep in mind, tuition continues to inflate the four years they are in school) in college expenses for our kids. Ouch. Of course, this is sort of a “worst-case” scenario considering most parents don’t have to pay “full retail” for tuition at most schools.

There are a variety of college scholarships, grants, tuition reimbursement plans (if employed), etc. that can help defray some of the costs. But if you’ve learned anything about me from the site, I like to aim big, so let’s work with these numbers for now.

Accounting for the modest amount we currently have in 529 plans, and a 7% growth rate of the funds (which may be a tad optimistic given recent history), that same website suggests we increase our monthly 529 savings plan contributions to $715 a month for our oldest child ($512 for our youngest). Okay, so it looks like we’ll be cash flowing a good bit of her tuition if she doesn’t earn any scholarships, because saving that amount would be a stretch.

We could take a little from our Roth IRA account because you are allowed to use a Roth IRA for education expenses (contributions may be withdrawn at any time, earnings after five years and only for qualified higher education expenses). Of course, this would certainly impact our own retirement, so this would probably be a last resort.

So what’s the lesson here? Start saving early! If my daughter was a newborn today, I’d only have to save about half of that monthly amount (roughly $450) to hit a target 18 years out. If I had only taken my own advice ten years ago.

Comments

  1. I have a two-and-a-half year-old daughter, so this write-up was very timely. We have a generic savings account for her, and we’ve been talking about a 529 plan for ages, but we just haven’t done it.

    But now that I read some of the comments, I wonder if a 529 is definitely the way to go. Specifically, I’m curious about what Bill (#1) wrote — if my daughter doesn’t go to college (or gets a full ride somewhere, god willing) what happens to that money? Does a 529 lock it up?

  2. I am HUGE proponent of not funding a college education for a child at 100%. Kids need to have a vested interest in their own education. They need to work summers, part time while in school, strive for scholarships, figure out their path (community college, vocational school) on their own. They need to own their education instead of having it handed to them. I was a prime example of the opposite: full ride (housing, spending money, car, etc.) handed to me by parents. I wouldn’t wish that on my own kids in a million years.

  3. @Scott

    Thanks for the info. That seems pretty bogus — “You’ve saved all of this money, but if your child doesn’t go to school, you have to either give it to your nephew/niece or take a 10% hit.” But there does seem to be a caveat if your child gets a scholarship.

    @Lisa
    That’s a great point. I think giving your kid a full ride only makes him/her think, “Hey, I can go through life like this, and stuff will just be handed to me!”

  4. there are other options than 529 Plans which are very restrictive in how they can be used. I am cashing out the 529 we have for my daughter – only child and can cash out w/ no tax implications since it is not back to pre-crash highs – and moving that into another option where I have control how it gets used and if she decides not to go to college I’m not facing penalties, taxes, or having to give it another family member to avoid those.

    Bill

  5. @Anthony

    Thanks for providing a concrete example. Very helpful.

    But even Louisiana’s great perks still leave the issue: What if my daughter doesn’t need it? What if she doesn’t go to college, or what if she gets a full ride?

    So I went to their website and scrolled through the FAQs, and here’s what it says:

    If the beneficiary does not use all or some of the monies in his/her START account, the funds
    may be transferred to an account for another beneficiary who is a family member of the original
    Beneficiary, or the funds may be refunded. If the monies are refunded, the earnings included in
    the refunded amount become taxable by the federal and state governments and may be subject to
    a 10% of earnings tax imposed by the IRS. Monies withdrawn up to the value of scholarships
    will not be subject to the 10% additional tax. Refunds will not include any Earnings
    Enhancements.

    This gives me pause, but I suppose it would be silly not to pursue this on the chance that my daughter might get a full ride.

  6. and college costs can be defrayed by: joining the military, taking the first 2 years at a community college, taking online classes, and CLEPing out of certain core courses which means that you get credit for them but don’t have to pay for that credit…

    these are all workable plans. another plan is to pay for them to get a workable skill (at a tech college) and then if they want to get a degree, they have a skill to fall back on, and they can work their way thru college. nothing says you have to do college the traditional way.

  7. Bill and Micki both have great ideas. FD, you may have missed my comment yesterday. Why do parents insist on the traditional 4-year degree? Dollar for dollar, a vo-tech or trade school education will increase a person’s earning potential far greater than anything done in a 4-year university (assuming no further education such as law or medicine or other high paying degree). Why not check into the bountiful opportunities in the certificate programs and associates degrees that are available everywhere? And yes, there are scholarships for those schools to, or even better, full-ride apprenticeships. The days of the 4-year degree are fast on the decline. I believe if college costs continue to outstrip gains in wages/salaries, we’ll see more and more people refusing to go that route and instead focus on learning a career path that will pay the bills. Following ones dreams is great, but getting paid a decent salary and avoiding thousands in student debt is priceless (not to mention…FRUGAL).

  8. Does the annual college cost include housing?
    I live in Canada and went to a top canadian school to earn my degree and it was around $6,000 a year plus housing which was around 8,000- 10,000 depending.
    Books were also another $1,000 a year if i had to buy new, but I never did and managed to get them for $500 used.

  9. @Bonnie: Yes, according to the website I used to run the calculations, “these average costs include all expenses (tuition and fees, books and supplies, room and board, etc.).”

    @Sid: I completely agree. I think as the costs of attending 4-year, traditional schools increases, we’ll see more people take what we now think to be the “non-traditional” path, which may include, military service, or a few years of work or short apprenticeships right out of high school.

    Which leads me to another concern alluded to in the first comment from Bill. What if we save up thousands in a 529 or other education savings plan, but our kids don’t attend college, or find cheaper ways to go. Would hate to pay penalties plus taxes on that money if I couldn’t pass it on to another beneficiary. Maybe those investing everything in taxable accounts are smarter than the experts think. They can tap that money any time, for any purpose.

  10. @Joel

    We just set up a 529 for our 1 year old son. As far as we understood, if your dependent gets a scholarship or doesn’t go to school the funds can be transferred to another beneficiary.

    From the site:
    “you can close the account and receive the balance at any time. There is a 10% additional federal tax for withdrawing funds this way, and federal and state income taxes must be paid. The penalty is waived if the distribution is due to the death or disability of the beneficiary or if a scholarship or nontaxable grant is awarded to the beneficiary.”

    Sounds like the worst penalty is if you have no other beneficiaries and your daughter doesn’t attend college. Then you have to withdraw the money with the 10% penalty.

  11. Hi Frugal Dad,

    What state are you in? That sounds ridiculously expensive for in-state schools.

    I also think college tuition is a bubble that is going to burst eventually. Just like weddings, people think they need to blow as much money as possible on college, even if they only end up with a $30k/year degree, which can only be afforded by super-cheap government backed loans.

  12. @Lisa: I’m proud of the fact I put myself through school with minimal help from my mom (after all, she was a single parent doing her best without any help from my father). However, my wife and I find ourselves in a different position and would like to help, but not hand out, with tuition and other college expenses.

    In my own experience, I began taking college most seriously only after I had to pay the tuition myself!

  13. Between my scholarships and part-time jobs, I only had to borrow $8000 from my parents during the last three years of college. I believe my first year cost a little less than $8000 and I helped cover some of that as well. All together my parents invested less than $15,000 to my college education.

    Yes, that is a bunch of money, but it isn’t nearly $200,000. Of course, my whole education would have only cost about $60,000 at UH even if I didn’t have scholarships. Housing and food was about $25,000 for the 4 years. I’m thinking the $200,000 must be for colleges like Harvard or Yale, right?

    I think high school seniors should apply for every scholarship and grant they possibly can and save money from their teenage jobs to fund as much of their own education as possible. If they made awful grades because they didn’t try, maybe they shouldn’t immediately go to college anyway. Also, I agree that community college is a fantastic way to knock out some of the core curriculum.

    I even think college students should have a job (on campus jobs are convenient), but I understand that may not be possible if they are trying to get an intense degree. Parents who are able could help by covering the bit that’s left so that their kids won’t be in debt when they graduate, but I don’t think parents should be on the hook for ALL of the expenses.

    Supporting themselves through college will help them understand finances and responsibility. It will also motivate them and make them feel like they earned it at the end. Yes, college should be fun. I do regret not staying in the dorms for an additional year. It was awesome. BUT, I did grow up when I started paying for myself my second year. My GPA jumped from a 2.98 to a 3.33 in one semester. I made the Dean’s List a few times and graduated Magna Cum Laude.

    I already knew how to budget, but I really understood myself and my money by the end of it. My husband and I got married one week after my graduation and started our married life with no debt. It worked out great!

    If you want to help, please feel free…I’m just saying that the kids should pitch in too.

    Your kids will be entering the real world and should understand that their parents can’t carry them through it all. Parents are great for support but shouldn’t be used as crutches through life. Even parents deserve to fund their own lives as some point. :-)

  14. I took so long to write my post that I see a bunch of people agreed with those ideas in the meantime. Preaching to the choir… :-)

    Good luck to all parents and kids! College is a turning point. Budgeting for the help you want to give your kids is really smart and a great way to make sure you don’t bankrupt your retirement in the process. :-)

  15. @ Jen — >>hey, mom and dad will help out if it all goes wrong!<< –that was me, I didn't get my stuff together until well into my late 20's when my parents finally cut me off! Go figure!

    I have sat down with my kids, even though they are only 12, and gone over what college is all about, what it costs, talked about making your time there worthwhile and have outlined that we as parents will help out as much as we can, but that we expect them to toe the line and contribute to the bulk of that. They are already designating babysitting money and monetary gifts to their own college savings account. One of my daughters can't wait until she 13 and allowed to get a summer job at one of our local tourist attractions. She keeps telling me she "needs to save" for college. They are also both sharpening their essay writing skills to apply for scholarships when it comes time. That is of their own volition after they heard about a girl on Dave Ramsey's show that got $30K in scholarships just by writing essays. I am *hoping* this kind of attitude will stick with them throughout life. It is a marked change from my own upbringing where I was handed everything on a silver platter and learned to appreciate nothing.

    Another avenue would be to check out your own alma mater — a lot of colleges offer legacy children a tuition break. Other states have substantial scholarships just waiting for the taking (University of Wyoming, for example, has the Hathaway scholarship which guarantees tuition assistance to all hs graduates in Wyoming based on GPA — the higher the GPA, the more the award)I know those schools might not be your child's first choice, but whose to say you can go for a huge tuition break and get your basic credits out the way and then transfer to your U of choice in time to have the name on your diploma.

    Just a few thoughts —-

  16. I’m currently socking away enough each year for my daughter (21 months) to get the matching 20% grant we get on education savings in Canada.
    It won’t nearly cover all the expenses, even with average growth, but at least it’s something…which is more than I had when I went to college.
    It took me a while to dig out of my college debt, but I’m all the better for it. I was, however, very jealous of others whose first paycheck went to a car vs. mine going to a loan payment. Of course, I know better now.

  17. The comments here have been great.

    I signed up for Louisiana’s 529 because:
    1) I can deduct $4800/year from state taxes and
    2) Louisiana matches a percentage of your contributions (no limit on match, match is between 2%-14% based on income, I get 2%).

    I still have plenty of debt to pay off, and I have a long way to go before I contribute the max to my retirement savings. That being said, I plan to put $10/month to my daughter’s 529. Not a lot, but it’s something, just in case she needs it.

    Here’re some thoughts:
    1. Does a 529 apply to “traditional” colleges only? Can’t a 529 be applied to tech schools or community colleges as well?
    2. As I understand it, beneficiaries can change, without penalty, if they are blood-related to the original beneficiary. If I have another child, I could just transfer from my daughter to the other child. Also, I’d assume that I could transfer the funds from my daughter to myself (if I wanted to go back to school again one day)?

  18. My parents paid my rent (dorm housing and later an apartment) through collage and I covered my tuition, books, fees, and food. Any scholarship money I could secure went toward my part of the expense. My parents were up front with me about this and I took it into consideration when choosing my school, choosing my classes, and saving my money from high school and college jobs. I did not qualify for any federal assistance with the exception of a fluke $2,100 subsidized loan, which I took out and used as my emergency fund through college and will pay it off without a penny of interest when I finish grad school.

    This arrangement worked out really well for my parents and I and it will be easy for them to repeat with my other siblings. A big part of this plan being successful is to make certain your kids know how their education is being financed and actively work with them to save up for their part.

  19. @Joel:

    I agree with you. I went through a self-debate about the pros and cons and what-ifs. In the end, I figured $10/month, plus a contribution match and tax benefits, is justifable, even if my daughter doesn’t go to college. The funds could be transfered elsewhere, to another beneficiary.

    If she gets a full ride, I would be taxed regularly without penalities on the earnings.

    It’s a “risk” I’m willing to take.

  20. I did go the military route, though part-time in the National Guard. When I went through, it was pretty much a monthly drill check plus the GI bill (plus loan forgiveness, but I never had any loans…should have taken some…kidding!). Now it’s even more generous. State and federal both combined should cover most in-state public university tuition and books. Throw in the GI bill and the GI bill kicker and you’re making money to go to college. When I graduated I had no debt and a paid for Camaro. It’s not a bad way to go except for those darned deployments.

  21. It’s funny, I am torn as to whether to try and help my kids with college or not. On the one hand, I had a lot of loans and it took me a decade to pay them off. On the other hand, I have a lot of friends who continue to get parental help with loans, down payments, etc. even into their 30s and it seems like they work less and save less because of it. I think it’s somewhat crippling to have your parents help financially and it causes people to make poor choices because, hey, mom and dad will help out if it all goes wrong!

  22. I liked what Melissa’s parents did…covering the housing but leaving everything else to Melissa.

    That sounds like a straight-forward way to help, but the kid would still learn financial maturity. I love it!

  23. I disagree with several of the comments above discouraging fully funding your child’s college expenses as a “free ride”. It is only a free ride if you communicate it that way. My parents funded my college expenses (except for personal expenses, they didn’t pay for stuff that had come out of my allowance in high school, for example). I consider that to be the best gift that they ever gave me and have always been extremely grateful. They communicated to me that education was very important and that they would pay once (private high school, college, or grad school; my pick). I was the one writing the actual check to the registrar, so I knew how much tuition and room and board were. I was the one writing the checks/paying the credit card so I knew how much I spent on books etc. At the end of every semester I went back through my Quicken account and determined how much had been spent from my parent’s funds and how much from my own account. I did work internships in the summer (as an engineer they were paid internships) to support my personal expenses.

    As a result of not having to work during school, I had the flexibility to do a varsity sport one year, do undergraduate research another year, take summer school classes, take classes within my interests that would not contribute directly to my major, and volunteer full time one summer. Additionally, since I graduated with savings and no debt, I was able to take a couple of months off after graduation to “stuff my brain back in my head and let it solidify” before entering the work force full time.

    So I don’t think that fully funding a child’s post-high school education is necessarily a “free ride”. (Although, the number of people in my grad school whose parents were still paying did put me off; for me that was the line where it became a free ride.)

  24. I had to chime in since I have actually done this.I paid for my daughter’s undergad(18K for 4 yrs) and grad program(approx 8K a year at NY state college) she then paid for 2nd masters at University of Rochester at 30K per year because she was married she declined any more help.I got extremely lucky- she worked almost full time the entire time,got good grades,packed her lunch yada yada BUT we both agree the person going to college needs to be vested.So several ideas of other writer’s is right on track.Even if you can pay for college you might want to ponder?? the money can always be given after words to pay off the school loan or help with a house instead.I am very supportive of other types of education like the trades as we see now not every grad is finding a job must less a career.

  25. Another thought: use contributions from a ROTH IRA to help fund your child’s education. Granted, it is not generally a good idea to borrow from retirement, but since there is no tax penalty for taking out contributions, it may be worth considering. If your child does not need the support, the ROTH IRA would remain accessible to you for retirement.

  26. I am curious — how old does a child need to be to open their own ROTH IRA and make contribution? If that was maxed out yearly for them at a young age couldn’t they then use the funds for college or if they didn’t end up needing them, they would have a heck of a start on their own retirement acct?

  27. I don’t think it has to be all or nothing. We put 12.5% toward retirement (started mid 20s) and are socking away what we hope will be 25% of the cost of college for each of our 3 kids. Its easy for us to switch the beneficiary to one of our other kids if one goes to grad school and another doesn’t.

    My husband and I had nothing paid for and everyone around us was supported by their parents. It made it really difficult to compete but there were a few who used college as a giant play time because they weren’t vested. It would be nice to go back to a time when kids could cashflow college but its so expensive now thats not an option you can take without serious delays.

  28. I admire you for your sensibilities… I am not planning on having kids yet but if I ever do then being in a financial grounded level and being able to provide for them, their medical expenses and their education are all MUSTS for me. I grew up reasonably poor and it’s just not fair to have kids on purpose and do that to them.

  29. Yet again, the earlier you can start, the better.

    Yikes, I hate to see what tuition is going to cost even further down the road. No wonder so many college students are loaded with debt.

  30. Given the changes in bankruptcy laws (student loans are not discharged), the best thing you can do for your kids is keep them from racking up huge debts for college. Help them understand how painful $50K or $80K in non-tax-deductible debt is going to be for them starting out. Once they are onboard, look at decisions that will mean big savings: Choice of school; starting out at a community college and transferring partway through; taking a year in the middle to work; going public for undergrad and targeting a private school for graduate studies.

    Higher education is way overpriced, and they can get away with it because people (kids) make emotional decisions costings tens of thousands of dollars through the use of debt. Ugly.

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