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Fear appeared on his face suddenly, when the topic of college education surfaced. Just because he's smart, educated and credentialed in finance, and wealthy didn't mean he's not concerned. I noticed the change in his demeanor on a Zoom call and it's a look I've seen more than once. Parents are scared about college. Unlike retirement in which certain expenses can be controlled, college is filled with a big unknown: ever-increasing tuition that's been outpacing inflation for decades.
Many parents want to give their kids a good start in life, without ignoring their own needs for retirement, healthcare, and daily living expenses. Often a good start means a college education and no student loans. There's more than one way for a young adult to get going in life but here I'll focus on college, and preparing financially for college expenses. Having put two kids through college, I've become aware not only of the high expenses but also of ways to control them and their impact on a family's well being.
You don't necessarily need to save for a full ride via a 529 Plan account or similar funding. But you may find that evaluating the potential costs and benefits (like tax credits) can help you plan smartly and alleviate fears. Here are steps to calculating what you'll need and how much to save:
Estimate future cost of attendance
The first thing to do is figure how much college will cost for your child. You don't have to pay the entire bill. But it helps to know the list price (cost of attendance) for this first step.
As a general rule, your child will have one of three choices when attending college:
- public university or college, in your state
- public university or college, in another state
- private university
To keep things simple, pick up the costs of attendance for the public and private universities your child is most likely to attend. These numbers can be found in the admission sections of each school's website.
Next, determine the percentage increase expected in these costs each year from now until your student's enrollment. Do the math to figure out how much college might cost your family. (Consider the average increase from 2018-2019 to 2019-2020 or look at the increase over 30 years.)
I never imagined that either of my children would want to attend a public university that wasn't in my state. But one of my kids decided on a narrow field of study with limited choices. And he fell in love with a university in a nearby state. Rather than tell him “no,” we paid a portion of the out-of-state tuition and had him take out student loans.
I can see various types of these scenarios. Rather than predict what might happen five, ten, or eighteen years from now, I'll suggest that you look at representative numbers for these categories and plan accordingly. In this way, you can bring your child into the conversation about college tuition earlier, rather than later.
Project student contributions
Figure out how much your child will contribute to college expenses. These contributions may come from sources such as:
- money earned from mowing lawns, babysitting, or employment, either during college or earlier, in high school
- college expenses avoided by graduating early, going to early college, etc.
When your child is an infant, you may have no idea whether she'll win scholarships or graduate early. But as your kid gets a bit older, you may have some inkling of talents that could generate cash or college credits. You could even require that your child contribute a certain portion of expected expenses.
Further, as the time to enroll in college gets closer, your child may get excited about early college (where a student can earn a high school diploma and college credits) or college credits during high school when the total bill reduction becomes clearer.
In my family, one child was able to work while he earned his degree, defraying some costs. Another stayed on track with his major and became a part-time student for his second-semester senior year, cutting the tuition bill in half.
Estimate student loans
You may be saving for college so that your child or children can avoid student loans altogether. Further, you may believe that your child won't be able to take out student loans.
You are free to exclude student loans from your calculations. But I've included these to allow parents a cushion of sorts when saving for college. By using student loan figures in your calculations, you could reduce the amount you save and still feel comfortable that your child can earn a degree, even if it means taking out some loans.
Currently, students can take out unsubsidized loans regardless of financial need. Parents or students must complete a FAFSA (Free Application for Federal Student Aid) but can qualify regardless of income, family investments, or 529 Plan balances.
Look at the amounts available now and project potential loan amounts in the future.
Determine extra cash at home during college years
When you're raising children, your thoughts may gravitate to considering costs that you'll incur because of them. The teenage years may be especially pricey as they get driver's licenses and require auto insurance, dive deeper into sometimes costly extracurricular activities, and take a series of trips meant to enrich their lives. But these years end, sadly, and then they do, you may find extra cash, happily.
Some of this extra money may surface because you're no longer paying for gas money or food (or more precisely, those expenses are included in the “cost of attendance” for college). Some may happen naturally if you pay off a mortgage or a car loan at the time your child goes off to college. Further, you may begin earning more money, perhaps because you've become a full-time employee, rather than a part-time one or because you're taking on more clients than before.
I've added this section because parents may stay more committed to an early mortgage, car, or credit-card payoff if they realize that this approach will mean setting aside less for college.
Estimate tax credits
Tax credits can be tricky but that's a good reason to consider them when planning.
There are several factors involved in qualifying for education credits. These include:
- your modified adjusted income
- out-of-pocket expenses for higher education
- your child's status as a student
If your income exceeds certain levels, you won't be eligible for a tax credit.
Further, you can't double dip on education-related tax benefits. So, you'll want to use funds to pay for educational expenses that come from cash flow rather than 529 plans or student loans. Currently, the AOTC requires just $4,000 of school expenses to snag a $2,500 per student credit while the LLC requires $10,000 worth of expenses for a $2,000 per tax return credit.
Successful college planning and savings doesn't depend solely on tax credits. But it makes sense to know how these may apply to your situation. Again, you might reduce your funding of a 529 plan slightly in order to avoid over-saving and at the same time, take advantage of tax credits.
In my situation, we didn't fully fund 529 plans but sold taxable investments to generate cash for college expenses. The investment income increased our income as did sales of company stock to fund a Roth 401k. So, in some years, our eligibility for tax credits was reduced. In hindsight, better planning could have helped us get the full extent of these credits.
Determine Total Needed for College
Now that you've projected costs and potential offsets to these costs, you can figure how much your student will need for each year of college. Then, you can determine the lump sum you'll need prior to the start of college.
Each year of college, you can draw a certain portion of your funds in your 529 plan or other investment account. At the same time, the remaining funds can continue to earn interest and dividends or experience investment growth. So, you'll want to consider this possible growth in determining the amount to save by the time your student is a freshman in college.
Calculate a Yearly Contribution to the College Savings Fund
Now that you've figured out the lump sum you want to accumulate, you can determine how much you should save each year to accumulate this total. The information you'll need for this calculation includes:
- money you've already designated for college savings
- expected investment growth each year
- your child's current age
- the age of your child as a first-year student
You can use the payment function in Excel to determine how much you should save each year from now until your student's enrollment in college.
Each year from now until college, you can update your calculations for changes in college tuition and expenses, investment growth, tax credits, and expected cash flow savings from mortgage pay-offs, etc. In this way, you can stay on track with your plan and make adjustments as needed.
I've created a spreadsheet to guide you in taking these steps. It's entitled The College Fund – How Much to Save spreadsheet course. You can download the spreadsheet and update your file each year to stay on track for college savings. It includes instructions along with formulas needed to project changes in costs, investment returns, and more.
How are you saving for college?