The Cost of Education
The birth of our daughter last fall was an incredible experience filled with every emotion imaginable. Looking at her little face and imagining life through her eyes — with everything to see and learn for the first time, every experience to come in the future — made us want to do everything possible to protect and provide for her. Amongst the number of things to think about, this got the wheels turning on planning for her future education expense, specifically college funding.
Laying the Groundwork
Your financial situation will determine the resources you can dedicate to education funding, but the amount you decide upon is usually a balancing act. Before looking at any of the numbers we need to consider your funding goals for this expense. Do you want to fund 100% or as much as your situation permits, or do you want your child to be responsible for paying part of their own way (many parents feel this makes the child value the education more). There is no right or wrong answer here, it is purely preference and what your resources will allow.
Before we get into the numbers it’s important to note that this process is part of the bigger picture (your holistic financial plan) that requires allocating resources for living expenses, retirement savings, and other mid/long-term goals alongside education savings. The general rule of thought is to allocate a minimum of 15% toward retirement and long-term goals prior to funding education accounts. Although, understandably so, parents typically want to prioritize the needs of their children and put them ahead of their own. If this is the case we recommend placing a set time period (preferably shorter term) for contributions to take priority in your plan.
We’ll be using a 529 plan from the state of Virginia as the funding vehicle to make our investments. 529 plans offer favorable tax treatment — our investment contributions are made on an after tax basis and grow tax-free when used for qualified college education expenses.
Now let’s get to the numbers. As of 2016 the average cost of tuition and fees for an in-state, four-year education at a public university was $20,0901. In recent years the cost has been increasing at a slower pace than previously, 3% for 2014 & 2015, and 2.4% in 2016, respectively the smallest current dollar increases since the mid-1970’s 2. My alma mater Penn State has gotten quite pricey with tuition and fees of $30,000-$33,000 (in-state) in 20163. I’ll need to plan accordingly if V wants to follow in my footsteps.
While inflation on education costs has been tame the past few years, historically it has risen at a higher rate. For our purposes let’s assume a 4% rate in our calculations (if you feel this is low you can adjust in your own calculations - it’s always wise to look at various scenarios). This means for a child born in 2016 and looking to start college in 2034, the total cost of education will be $172,953 (including inflation during 4 college years). This will be our baseline cost from which we base our planning efforts.
In this scenario we have 18 years to save $172,953 to fully fund the education expense. That’s a lot of money to save outside of living expenses, retirement and other mid-to-long-term savings goals discussed earlier. Luckily we have a few options, and we also need to remember this is a best efforts approach as determined by your current resources and goals.
By saving $290 per month for the next 18 years (240 months) and earning 8% interest annually on our investments we will manage 100% of our education expense goal. The net result is a total investment of $69,600 over the time period.
Investing $41,717 today and earning 8% interest annually will manage 100% of our education expense goal. As you can see by comparison the net investment is about $28,000 lower with this approach.
Like most people we don’t have an extra $41,717 available at the moment to use the lump sum approach, and looking at how much more money we would have to put toward the goal by using a monthly saving approach we decided on a combination of the two.
Our goal is to set aside $10,000 in each of the first two years and then $5,000 a year for over the next 6 years. That gives us a total funding period of 8 years. If we are able to manage our 8% growth rate over the 18 year period our investment will grow to approximately $172,0003. With this approach our total investment would be $50,000 for V’s education fund, somewhere in between the lump sum and the periodic options described above.
If this seems overwhelming or ambitious, please keep in mind this is the starting point - as time goes on we will re-evaluate the plan and make changes as needed. Over time many of our financial situations will change for the better and some for the worse. As all parents quickly learn, we just need to be flexible and make adjustments as changes occur, and understand that planning issues are a best effort item. If you can’t begin with a large amount up front that doesn’t mean you won’t be able to put more significant contributions toward the account later on. And remember, there are other resources available for college funding - scholarships, grants, and loans all exist to help students pay for their education.
As always, we would love to hear your thoughts, planning strategies, and success stories. Please share them with us!
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
Prior to investing in a 529 plan investors should consider whether the investor’s or designated beneficiary’s home state offers any state tax or other benefit that are only available for investments in such state’s qualified tuition program. Withdrawals used for qualified expenses are federally tax-free. Tax treatment at the state level may vary. Please consult with your tax advisor before investing.
These are hypothetical examples and are not representative of any specific situation. Your results will vary. The hypothetical rates of return used do not reflect the deduction of fees and charges inherent to investing.