College Savings 101 (2023 version)
Brett Detterbeck, CFA, CFP?
President / Investment Adviser at Detterbeck Wealth Management
Kids cost a lot. As financial planners, we know the expected average cost that a child can be to a family. As a parent, I know that the actual figure can be much more than that average. In this blog, I will talk about one of highest costs involved for many parents: college.
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College is important. Take a look at the graph below. For those students who graduate college, they have that much higher earnings potential which typically leads to improved livelihood. A college degree typically pays for itself by age 30. Further, college graduates enjoy much better job security and job opportunity especially during economic downturns.
But college isn’t cheap. College tuition costs have increased more quickly than just about any other household expense in recent decades with the average annual inflation rate at roughly 6% over the last five decades. The cost of college typically rises because schools continually spend more money to attract the best students as well as hire more faculty and administrative staff, while receiving less and less financial support from the states. Further, many institutions are starving for revenue after attendance fell during the pandemic. In a nutshell, we don’t see college costs getting cheaper any time soon.
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Take a look at the graph below to see where the average cost of public and private tuition is for a four-year program now for an 18-year-old versus what it could be for a newborn. Those figures could make any parent cry! The key is to start planning early. It’s also essential to be realistic about financial aid and making sure that savings earmarked for college is being invested.
By the way, less than 50% of students graduate in 4 years so keep that in mind. One way to really bring costs down is going the community college route, perhaps for the first couple years and then the college you really want for the balance. Staying close to home also allows the student to hold a part-time job where they can add to their education savings account for a few more years!
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The good news is that close to 60% of families receive some type of grant (which are based on financial need) and/or scholarship (which are merit-based). Unfortunately, the dollar amount involved averages?only about $5000 to $6000 per year.?Hence, understanding what the cost of college is per the graph above, this barely makes a dent. In fact, only three out of 1000 college students receive enough in grants and/or scholarships to cover their full cost – the so-called “Free Ride” is an extreme rarity these days. Regarding grants, one can check the?College Board Expected Family Contribution (EFC) Calculator?to determine their federal financial aid eligibility. Unfortunately, many of the families that we work with won’t be eligible.
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Many families wonder if a merit-based scholarship is in the making for their children. Scholarships are awarded for exceptional grades, exceptional test scores, exceptional athletics, etc. But as a parent that just went through the college application process with our youngest child, we know that the big name colleges are extremely competitive. Merit is really hard to come by unless that student is “perfect-perfect”, think 5.0 GPA and 36/36 ACT. When we went through the process 3 years ago with our older son, we were shocked at how such little merit was offered from the bigger schools that he applied to. No difference this time around with son Caden.
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The good news is that if you’re willing to go to a school that’s not in the “top 50”, your chances of a merit-based scholarship improves dramatically, and you may be able to save literally hundreds of thousands of dollars. For Caden, it appears we’ll be settling upon Iowa State instead of some bigger name schools, thus saving our family potentially $100,000+ over the next four years!!! Let’s go, Cyclones!!!
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Of course, there’s always the option of student debt, but it can be a major burden. Do you really want you or your child having that heavy weight above their shoulders right when they’re trying to launch their career and possibly start their own family?!? And don’t make the mistake of considering paying for college with your own retirement funds, jeopardizing your retirement security. That’s a big-time no-no!?
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By planning early, families can really make the process a feasible one versus one full of concern and anxiety. And one of the best ways to start is via a 529 college savings plan. These plans offer extremely nice benefits including:
NOTE:?There are other different vehicles for college savings including custodial accounts like an UTMA/UGMA or a Coverdale Education Savings Account, but we generally see the 529 as the best fit for our family and clients.
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While 529s seem to be a great fit for most, others in the past have been hesitant thinking “what if my kid is?not?built for college?” or “what if we overfund the 529?” Well, there’s new legislation, part of the SECURE Act 2.0, which takes effect in 2024, that is really wonderful! Now, one can roll the funds up to a $35,000 lifetime limit to the beneficiary into a Roth IRA in their own name. There is some fine print on the details on this so please see this quick read on?ROLLING A 529 INTO A ROTH IRA?from our friends at John Hancock for better understanding. This is really a great planning opportunity! If you’d like to discuss it further, please reach out to discuss!
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At the end of the day, it’s important to not just start saving early, but also to invest ASAP. With the inflation rate of college at 6% per annum, simply saving money in cash won’t get the job done. The sooner you start investing, the more time you have to grow your college fund via the power of long-term compounding. So, get into gear and put your college investing on auto-pilot with regular automatic monthly or semi-monthly payments and watch it grow! Here’s a great chart below to show exactly how much monthly investment is needed to achieve a public or private college funding goal. One can clearly see the importance of starting as early as possible.
In conclusion, we hope this blog provides those couples thinking about having children / more children a better understanding to what goes on with college planning essentials. As a financial planner and family member who has personally gone through the process twice in the last few years, I can tell you that the most essential part is getting started as early as utterly possible. As a matter of fact, I had a 529 plan established the day of Caden’s birth. Never too early to start!