How to pay for your children’s education
One big elephant in the bear cave is the price of a college education for the current baby bear and any hypothetical baby bears to come. We plan on sending them all to public school when they’re young, but even public universities have grown increasingly expensive in the US of late. So let’s dive into some data on how serious this problem really is, and then I’ll lay out our strategy for paying for the college educations of two little bears. The basic strategy is very simple. I wish there were more to it. But just like saving for retirement, saving for college is relatively simple. There’s no magic bullet.
- Develop a realistic picture of how much it will cost – all calculations were performed using Vanguard’s handy college cost calculator (did I mention that I’m a fan of Vanguard?).
- Decide how much you want to cover – Be realistic about what you expect from your kids and what you can offer.
- Start saving early – Before they are born is the best option.
- Use a 529 Plan for the tax benefits – These are tax-advantaged educational savings plans. The tax benefits are substantial over the course of 18 years. Get a taste of just how much with a handy 529 calculator I’ve whipped up for us to use. You can find it here (you’ll have to log in).
How much will it cost?
Over the last 45 years, the average real price at a four-year public university has increased by 2% per year. 2% may not seem like much but over time this adds up. The real price of a four-year degree has more than doubled over this time period from $8k to nearly $20k per year in 2015 dollars. This is a steep price increase and a difficult pill to swallow for any family. A four-year college education currently costs north of $80k for four years. With good jobs increasingly out of reach for those without a college degree, this is a very big deal.
We plan to fully fund our children’s education through undergraduate, so this is also a concern for the Grizzlies. We have one baby bear and at least one other hypothetical baby bear in the works. After another 18+ years of price increases, we are staring at a >$320k bill that will come due sometime in the 2030’s. Since we plan on retiring from our corporate jobs next year, this is something that has occupied a lot of our thoughts recently. We want to provide them a great college experience without forcing them to take on massive amounts of debt, but we also want to spend time with them now! How have we balanced those priorities while ensuring we take care of them financially?
But College is not as expensive as it seems
The most important thing to remember is that the cost of college is not everything it seems to be. That $19k price tag is the list price of state school, and everyone knows that no one actually pays list. The ACTUAL cost of college to a prospective future baby bear is significantly less than the list price. The graph below is a good indicator of just how much less:
Why is there such a big difference? The first piece is federal grant aid or scholarships that are often available. The second element is various federal education tax credits and deductions. Just those two things knock a little over $5k off the current price tag. Finally, there is a big difference between the cost of a good state school w/room and board and the cost of a good state school without room and board. Almost $10k worth of difference to live at home. All told once you make adjustments for these factors the true current net cost of a college degree is a bit under $4k or about $16k for four years. Not quite as daunting as the $80k for each child we started with. With just this $4k per year baseline plus 18 years of price increases, a college degree for our two baby bears would likely cost about $70k total or $35k apiece.
What expenses are we going to cover?
We’re going to save more for our kid’s college than $35k apiece. However, knowing that we COULD afford to send both to a decent school for just $70k provides a MASSIVE safety margin for everything that follows. We don’t actually have to save as much as we are planning. The vast majority of it is a pure luxury. It’s very important that we acknowledge that upfront. If you’re on a tighter budget than us, it is possible to save for college. We plan on covering the full $19k of instate tuition + room and board for all four years for both of our kids. That means we’re looking at the full $320k price tag.
Start saving early
So how are we going to manage this cost? The answer is that we’re already almost there! We started saving before our daughter was born and we already have around $36k saved for the current baby bear. At an 8% return with a 4% price increase per year, this is already enough to fund the projected $160k pricetag. We don’t need to contribute another dime to her. For planned baby bear #2, we will need to contribute $28k in the first year of his or her life. After that, we’re done. That $28k deposited in year zero will more than cover his or her education costs 18 years down the road. Taking advantage of the magic of compounding interest, just like for retirement, is the key to saving for college. For the lower amount needed to cover the net cost of tuition and fees, you only need to stash away $7500 in the first year of life to fully cover the $35k cost. Or about $60 per month.
But the key to all of this is another wonderful little gift from Uncle Sam. The 529 educational savings plan. All of our savings for both of our baby bears will be in 529 plans. Here’s why!
Use 529 Plans!
First, one of the best sources on the details of 529 Plans is our own friendly IRS. Check out their FAQ here.
529 Plans are tax-advantaged savings vehicles designed for educational expenses. They’re administered by a given state or educational institution. I.e., Nevada has a 529 Plan, Kentucky has a 529 plan, Kansas has a 529 plan, etc. There are two flavors of 529 plan offered – prepaid tuition plans and savings plans. Prepaid tuition plans generally allow you to purchase tuition credits in today’s $ for use later. Savings plans look much more like standard investment accounts with a selection of mutual funds available.
What are the tax benefits?
There are three primary tax benefits to 529 plans. One, if you are a resident, many states allow you to deduct contributions to their plans from your state tax returns. Two, tax-deferred growth. While you’re investing and growing your 529 plan you do not have to pay any federal taxes on dividends or capital gains and in many cases no state taxes as well. Your money can grow complete tax-free for 18 years. The final benefit is tax-free withdrawals, if you withdraw money from a 529 plan, as long as the withdrawals are for education expenses you do not have to pay any taxes on the gains.
These tax benefits can add up to a substantial difference in the life of a child. If you’d like to see the details of the calculation we have a simple calculator here (you’ll have to log in). Using the 529 plan vs. a normal taxable account allows you to save 17% more over the life of your child under normal circumstances.
Which 529 Plan should I use?
Each state’s plan is a little different. And generally you can invest in any state’s plan, you do not have to be a resident. So technically you can shop around. Vanguard has a great comparison tool to help you find the best 529 plan. But I’ll simplify it even further. There are really only two options and one question. Question: Does your state offer a tax deduction for investments in their plan? If the answer is yes, then go with your state’s plan. Invest in low-cost index funds, preferably Vanguard funds if they are offered, and enjoy your tax break. If the answer is no, then go with the Vanguard managed plan sponsored by Nevada.
We live in California which does not offer a tax break. As a result, we use the Vanguard plan. We have 100% of baby bear’s money in the Aggressive Growth Portfolio of that plan.
Any problems with a 529 Plan?
Only one big one. If the money in the plan isn’t used for educational expenses you can get hit with a 10% penalty on earnings along with all the normal taxes that apply. However, there are a few options to get around this:
- You can use the money to pay for more than just “college”—trade and vocational schools, for example.
- You can give the money to someone else in your family to use for college. A brother of a sister or 1st cousin qualifies.
- You can leave the money in the plan in case your child decides to attend additional school later.
That’s it, our four-step plan for covering our kids’ college education. It’s not flashy, but it will work.
- Develop a realistic picture of how much it will cost – For us that number is $160k per child paying full room and board at a state school. But a likely lower bound is around $30-40k per child if they are 1 year old now.
- Decide how much you want to cover – we’ve settled on full tuition, room, and board at an in-state public school. The money we save will be our daughters, so if she wants to go to a more expensive school (or a cheaper option!) she is welcome to, but the difference will be covered by her. However, Ivy Leauge undergraduate schools like ones the grizzlies attended aren’t as expensive as some people realize. I got mine for free through a ROTC scholarship!
- Start Saving Early – We started before baby bear #1 was born. The earlier the better in order to let your investments grow.
- Use a 529 Plan for the tax benefits – We use the Vanguard plan through Nevada, but if your state offers a tax break go with that plan. Invest in low-cost index funds.