By Brittany Mollica, CFP
As many parents will be quick to tell you, raising children is expensive. A client recently told me that her two teenage sons drink 8 gallons of milk per week - that alone adds up fast, never mind the cost of after-school activities, housing, clothing, etc.
The cost becomes dramatically higher if you also help pay for your children to attend college. For context, the College Board’s Trends in College Pricing and Student Aid 2020 report found that the average annual cost (including tuition, room and board, books, transportation, etc.) in 2020 for a public, four-year, in-state school is $26,820 per year. This figure jumps to $54,880 per year when looking at a private, nonprofit, four-year school.
Given how expensive college (and children in general) can be, it’s important to plan ahead. Here are three steps for setting and reaching your college savings goal.
Step 1: Let’s think big-picture. What is your overall college savings goal?
There are many routes you can take when setting your goal. You may want to pay for your kid to go to college no matter how expensive the school is. Or maybe you’d rather pay for the equivalent of a four-year in-state school, but if your child goes to an out-of-state or private school, then it’s up to them to fund the difference. Alternatively, you might decide that they should have “skin in the game” and so rather than contributing financially, you assist them with taking out student loans and/or getting a part-time job. In the end, there is no right or wrong approach to education planning - although as a UNC-Chapel Hill alumna, I can promise you I won’t be paying for my future children to go to Duke!
One final note: don’t forget to think about your education goal in the context of your overall plan. Will you be sacrificing your own future (such as having to delay retirement) by prioritizing a college savings goal? In that situation, I urge you to consider putting yourself first - your child will have plenty of time to pay off student loans after school, but you may have a limited amount of time to save for retirement.
Step 2: You’ve determined your goal, so we’ll talk money. How much will it actually cost?
This is where you should do some research and crunch the numbers (or have your financial advisor run some projections). In the end, you’ll want to know the total cost for your goal, adjusted for inflation. Here are some quick steps to get a reasonable estimate of this expense (simplified but close enough):
1. Determine how many years away the expense is, i.e., how many years until your child will go to college.
2. Multiply the current annual cost by a reasonable percentage for inflation for each year until college starts.
For example, if my goal is to pay for a public school, I might find that the current average annual cost is $25,000. If my child is 4 years away from school and I assume an inflation rate of 5%, I would multiply:
$25,000 * 1.05 * 1.05 * 1.05 * 1.05 = $30,387
3. Finally, multiply that number by the total number of years of college you want to pay for, and you’ll have a rough estimate of the total cost in future dollars.
Continuing my example above, we’ll assume I want to pay for 4 years of school.
$30,387 *4 = $121,551
Step 3: You’ve estimated the total cost. Now what?
First: don’t panic if the total estimated cost seems like a staggeringly large number. You can always adjust your goal if it doesn’t align with your financial situation. But also, depending on the time horizon until college starts, it will likely make sense for you to invest your college savings and take advantage of growth in the stock market.
If college is 3+ years away:
Consider opening and funding a 529 plan. 529 plans are tax-advantaged investment accounts specifically designed for education savings. The primary advantage of a 529 is that any investment earnings are tax-free upon withdrawal if you use the funds for a qualified education expense. Depending on what state you live in, your contributions to the account may also be tax deductible. However, if you withdraw funds for a non-qualified expense, you pay income tax + a 10% penalty on any investment earnings. For that reason, I recommend that you avoid over-funding a 529 plan – you may want to target having a 529 balance of ~50% of the total estimated college cost.
Contributing to a Roth IRA can also be a strategic way to save for college. Although Roth IRAs are intended to be retirement savings vehicles, you are generally able to withdraw the dollars that you contributed without incurring any taxes or penalties. This makes Roth IRAs a convenient way to save for retirement while also building in flexibility for funding college expenses.
Investing in a non-retirement brokerage account is another method of saving for college that offers great flexibility and liquidity. While these accounts do not enjoy any particular tax benefits, there is no limit to how much you can invest and you’re able to liquidate and withdraw funds at any point, although you do still need to be aware of potential market volatility.
Finally, cash accounts can be a simple way to supplement your college savings. Whether you build up a savings account specifically for education expenses or plan to pay for some college bills out of regular cash flow, this is a good option that doesn’t involve market risk.
If college is less than 3 years away:
Any of the above investment accounts could still make sense for college savings, but you’ll want to be sure to invest in a more conservative allocation to protect the funds from market volatility since your time frame is shorter. For the same reason, building up cash accounts will also be a smart tactic.
Following these steps will help you establish a plan for college savings. However, the more time you give yourself to save for your kids’ college expenses, the easier it will be to balance all your financial goals.
About the author: Brittany Mollica, CFP®, CSLP®
Brittany Mollica is a financial advisor at Hilltop Wealth Advisors, a fee-only wealth management firm located in Chapel Hill, NC. She primarily works with young professionals, helping them lay the foundation for a successful financial future through holistic financial planning and strategic investment management. Brittany can be contacted at firstname.lastname@example.org.
This material is provided as a courtesy and for educational purposes only. Please consult your investment professional, legal or tax advisor for specific information pertaining to your situation. Asset allocation and diversification do not assure or guarantee better performance and cannot eliminate the risk of investment loss. The information contained herein is believed to be true as of the date of publication. It may be rendered out of date by subsequent legal or tax-rule changes, as well as variable economic and market conditions.
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