Is a more expensive college for my child worth the cost?
First, let’s dispense with the notion that the more expensive the college, the better the education. More prestigious schools tend to offer generous aid packages, often making them less expensive than less elite ones. However, if you are deciding between an elite school that actually is more expensive and a less prestigious school offering more aid, two key studies both reached the counterintuitive conclusion that, even though graduates of prestigious schools earn more than those from less selective ones, one’s alma mater does not actually boost one’s earnings. They did, however, find a correlation between the schools to which one applies and one’s future earnings. That means someone with a 1400 SAT score who went to Penn State but applied to the University of Pennsylvania will earn as much as someone with a 1400 SAT who went to Penn. They speculate that the mere fact of applying to a top-notch school gives an indication of your ambition, drive and future earnings.
The exception? People from disadvantaged groups such as blacks, Latinos, low-income students and students whose parents did not graduate from college will benefit from attending more elite schools.
Just as few people buy houses with all cash, most parents shouldn’t expect to save up 100% of their child’s education costs, says Mark Kantrowitz, senior vice president and publisher of edvisors.com, publishers of websites about planning and paying for college. He recommends covering a third of costs from savings, a third from current income (your earnings during the college years) and a third from your future income (in the form of loans). If you don’t want you or your child to take on debt, then aim to save two-thirds. “It’s cheaper to save than to borrow. Because every dollar you borrow will cost you $2 by the time you pay the debt. The difference being that if you save, not only are you eliminating those loans, but you’re earning the interest rather than paying the interest,” he said.
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When should I start saving and where?
Start saving as soon as possible. “Time is your greatest asset. If you start saving from [the child’s] birth, a third of your college savings goal will come from your earnings. If you wait till the child enters high school, a tenth of the goal would come from earnings and you would have to save six times as much per month,” said Kantrowitz. But be sure not to set up a taxable account in your child’s name, because that will do more to cut your aid eligibility than the same amount of money counted as a parent asset. The best investment vehicle for saving for college costs is a 529 savings plan, which functions similarly to a Roth IRA in that your contributions will be taxed but the earnings will not. Set one up either right after the child’s birth or even before (designating yourself the beneficiary and then changing it to your child after he or she is born). Check out your own state’s 529 plan first to see if it offers you additional tax benefits. If not, go with one that charges the lowest fees.
How should I save and invest the money?
Continually invest by setting up biweekly or monthly automatic transfers from your savings or checking account into the 529. If you have a newborn child this year who will be going to an in-state public college, save $250 a month; for an out-of-state public college, $400 a month; and for a private nonprofit, $500 a month. “Whenever you have a windfall, like a big income tax refund, you have an inheritance, you win the lottery, you get a bonus at work, take at least half that money and put it into college savings. Any time a regular expense ends, like your child no longer needs diapers or day care, take the money you were spending on that and redirect it into college savings,” said Kantrowitz. To invest, use an age-based allocation which will start with more aggressive (and therefore riskier) investments. That will give your money a chance to grow more quickly early on but also build in time to recover if the market goes south. The allocation will become more conservative as your child approaches college.
How do I prioritize my child’s college education against retirement and other financial priorities?
Always prioritize saving for retirement over saving for your child’s education. Your child can always take out loans for college, but there are no loans for retirement. If you balk at the idea of their having student loan debt, just remember that if you fall short of your retirement goal, then they’ll have to support you later on. Additionally, assets in retirement accounts like Individual Retirement Arrangements (IRAs) and 401(k)s are exempt from financial aid calculators, so having the money there will lower your apparent net worth. Other financial tasks that come before college savings include maxing out your retirement contributions, funding your emergency savings, and paying off credit card debt.
How can I lower costs?
First, strategically place assets in accounts where they’ll be shielded from the financial aid analysis. For instance, if the grandparents want to help pay, they should wait until after the aid offer has been made and the bill has arrived, and then send just one year’s worth of a gift to the parents. If you will have more than one child in college around the same time, increase the number of family members enrolled at the same time to boost your aid. Have the older child take a gap year after college so that her college years overlap with those of her younger brother for three instead of two years.
Consider getting a degree abroad. While costs and student visa rules vary from country to country, many offer equivalent degrees for less. Plus, three-year undergraduate degrees are not uncommon abroad. Another option: Start out at a community college and then transfer to a state university.
This is the third in a series of four stories. Read the related articles: How The College Pricing And Student Loan Systems Hurt Students, Is College Even Still Worth It? and 3 Education Experts On Ways To Improve College Pricing And Payment
Laura Shin is the author of the Forbes eBook, The Millennial Game Plan: Career And Money Secrets For Today's World. Available for Apple iBooks, Amazon Kindle, Nook and Vook.