College Savings: How Much Is Enough?

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So how’s that college fund going?

If it makes you feel any better, my oldest child will be 16 in March, and I just opened a college savings account for her last month. Yes, this is procrastination at its finest.

While the mortgage, insurance and utility bills are big reasons why I put off starting a fund, a secondary reason was simply not knowing how much to set aside. I told myself I’d figure it out later, and once I knew the number, I would open an account. However, the years rolled by instead.

Maybe you can relate. If you’ve wanted to start saving for college but feel lost when it comes to a dollar amount, this article’s for you.

By the numbers in 2014

Let’s start by looking at what other parents are doing.

The Sallie Mae “How America Saves for College 2014” report provides a fairly comprehensive look at the state of college savings accounts today. According to the study, 51 percent of families with kids younger than 18 socked away some cash for college this year. That’s even though 80 percent of parents report a willingness to stretch themselves financially to save for college.

On average, college savers begin setting money aside when their child is about 6, and the average college savings account contained $15,346 in 2014. While that may seem like a healthy balance, it’s a drop in the bucket compared with what some four-year degrees cost.

The College Board reports the following national average sticker prices for higher education in 2014-2015. These prices are per year, not per degree.

  • Public two-year school (in-district) — $3,347.
  • Public four-year school (in-state) — $9,139.
  • Public four-year school (out-of-state) — $22,958.
  • Private nonprofit four-year school — $31,231.
  • For-profit school — $15,230.

That’s just tuition and fees. If your child plans to live on campus, add another $7,705 to $11,188 for room and board.

Assuming you pay the sticker price, a four-year bachelor’s degree earned at a private school by a student living on campus could cost you nearly $170,000. And that’s at 2014 prices. You could be paying a lot more 10 years from now.

Determining your sweet spot

So, we’ve established that college costs a lot of money. Now, it’s time to ask yourself whether you need to pay all that money yourself.

Here’s where your personal parenting philosophy comes into play. I know some parents who feel their financial obligation to their children ends with high school graduation. At that point, if a child wants to go to college, the cost is entirely on them. Seems a bit extreme to me, but to each their own.

On the other end of the spectrum are parents who will do anything to send their child to their dream school. These parents may even sacrifice money for retirement in favor of a college savings account.

Rather than go to extremes, I advocate finding your savings sweet spot. To find that sweet spot, you need to weigh what you consider to be your obligation to your child with what you can realistically afford. Ask yourself these questions:

  • What do I believe is my responsibility to my kids as they transition to adulthood?
  • If paying for college is one of those responsibilities, what are my financial limitations?
  • Are there community colleges and public universities within commuting distance?
  • Can I realistically expect my child to earn a scholarship of some sort? (You’ll be able to gauge this best if you have tweens and teens. Trust me, every 2-year-old is brilliant, but they’re not all going to get scholarships.)
  • How much student loan debt do I want/expect my child to graduate with?
  • Will our income make us eligible for grants or other assistance?

Once you start running through these questions, a good picture of your expected college expenses should emerge.

In my case, while I’d love for my kids to go a prestigious (read: expensive) private school, I’m not made of money. Instead, my hope is to be able to pay for two years of community college tuition plus two years of public university tuition. We have decent schools within driving distance, so I am not planning for room and board.

Of course, my kids will be free to go to any school they choose or live on campus if they want. However, I’ve decided my obligation ends with covering tuition at nearby affordable institutions. Anything above that will be their responsibility.

Getting enough interest is key

Now, it’s time to start saving. Some financial experts advocate putting 10 to 15 percent of your income aside for college and hoping that’s enough. But I prefer a more exact savings method.

Using 2014-2015 rates, two years of community college and two years of public university will cost a total of $24,972 in tuition and fees. I divided that number to get an average per-year cost and used this savings calculator to determine that I need to put aside roughly $355 a month, about the same amount as a car payment, if I want to save enough for my nearly 16-year-old.

Meanwhile, if I were to start saving today for my 2-year-old, my monthly cost would be $80. Both scenarios assume I earn 10 percent on my investments each year and that tuition costs increase 3.8 percent each year.

That 10 percent is the catch. If your college account doesn’t earn enough interest, you’ll be short of your savings goal.

And that’s a distinct possibility for the 45 percent of families who, according to the Sallie Mae report, are using a general savings account for their college fund.

Do you know how much interest a savings account earns these days?

I’ll tell you. It’s somewhere a hair above zero. I think my credit union gives me something like 0.1 percent. No, that’s not 1 percent; it’s one-tenth of 1 percent.

Seriously, you need something better for your college savings fund.

Picking the right college account

Personally, my pick for college savings is a 529 plan. Other good options may include prepaid tuition plans, Coverdell Education Savings Accounts or even Roth IRAs. MTN’s resident finance expert, Stacy Johnson, explains the basics of those options in this article.

The one drawback of 529 plans is the money must be used for education purposes, or you incur a penalty when you withdraw it. While you can change the beneficiary of the account to other children or grandchildren, that option may not work if you have an only child.

In that case, you could try a novel approach to college funding that combines your education and retirement savings. Deposit your college savings in a Roth IRA along with your retirement money. Then, when Junior heads to college, you can pull out your contributions penalty-free to be used as needed. Meanwhile, leave the investment gains in the IRA to continue growing tax-free. You don’t get any interest for college, but you get that interest as a boost for retirement.

This option may be particularly good if you’re not sure your child is college-bound. In the event they opt out of higher education, you’ve lost nothing. The only negative here is IRS rules that put a cap on Roth IRA contributions. High-income households may also not be eligible to open a Roth IRA account.

As a final note, government savings bonds are the traditional way to save for college, but they tend to be a lousy investment. Tell Grandma thanks but no thanks and give her a deposit coupon to your kid’s 529 plan instead.

For more about how to pay for college without loans, check out this video from Stacy Johnson.

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