Many new parents want to pay for their child’s college education, but it’s hard to know how much money they’ll need 18 or 19 years in the future. The type of college your child goes to, education inflation and many other variables affect how much you need to save.
With some thoughtful planning, you can come up with a reasonable estimate of your “magic number” for college savings. Following are some important considerations as you start planning:
• Type of school: The cost of attendance varies greatly depending on whether it’s a two- or four-year public or private school. Costs ranged from around $11,000 to about $44,000 (including room and board) per year in 2015, according to a recent survey from the College Board.
• Room and board: This accounts for a large portion of the cost of attendance, and is one area where you can save money. Having your child live at home for the first year or two may help you save enough to pay for a year’s worth of tuition.
• Inflation: According to the College Board’s recent study, prices increased by about 3 percent from the 2014-2015 school year to the 2015-2016 school year. It’s best to err on the side of caution and choose a relatively high rate of inflation — say, 5 percent — as you calculate how much money you’ll need to save.
• Price actually paid: Many students don’t pay full price because of institutional and federal grants and tax benefits. The College Board found that for a four-year public university with a list price of $19,550 for the 2015-2016 school year, the average in-state student actually paid only $14,120. Private university students also saw a significant discount from a list price of $43,920 to $26,400. Though it’s difficult to know exactly what discount your student can count on, planning on a 20 percent to 25 percent discount is often reasonable.
• Your child’s contribution: Many parents believe their child should help pay for school through work or student loans. This can motivate and engage the child. However, if you decide to have your child contribute with student loans, make sure he or she is aware of the risk and burden involved in taking on debt.
• Family contributions: Some grandparents agree to pay for some or all of their grandchildren’s education expenses. But not all families have this luxury. Most fiscally conservative parents will not count on the help of family members unless that help is just a couple of years away. Talk to your family members to find out whether this is something they are interested in or able to do.
Determine your monthly savings
To see how all of these factors affect college planning, consider this example.
The Johnstons want to plan for college for their new baby, and they already have a school in mind. The estimated in-state cost of attendance for 2016-2017 at the University of Minnesota is about $26,482 in total per year. They decide to cover tuition for four years, but plan for a 25 percent discount to the listed price and to have the child be responsible for room and board, plus books and other personal expenses (around $12,200 of the $26,482). If necessary, their child can live at home to reduce costs.
Here’s how the Johnstons arrive at their magic number:
• They determine the portion they’ll cover per year, or $26,482 – $12,200 = $14,282.
• Plan on a 25 percent discount to the list price, or $14,282 x 0.75 = $10,711.50.
• For four years, that’s $10,711.50 x 4 = $42,850 (rounded up).
• Then they adjust today’s cost for possible inflation at 5 percent over 19 years, or $42,850 x (1+0.05) 19 = $108,280.
With a 7 percent rate of return on their college savings (a reasonable assumption based on historic Standard & Poor’s 500 index returns and a 70 percent to 80 percent equity portfolio), it will require saving $228 per month to reach their goal of $108,280 in 19 years.
If the Johnstons waited to start saving, they would have to save significantly more each month. For instance, assume that they have only 10 years to save for college. Instead of $228 per month, they would need to save $625 per month, assuming the same costs and returns.
Update and be flexible
Of course, the Johnstons also realize that they will have to review their plan every so often and make adjustments as needed. If baby Johnston wants to go to the top engineering school in the country, it will most likely cost more, and living at home won’t be an option.
Planning for college savings must be an ongoing process, and talking with your spouse and/or an adviser early on can be invaluable. Plan for your best guess, but be flexible.
Unless you have unlimited resources for college, you should set up a reasonable plan for savings, make periodic adjustments as necessary and make the most of what you have.
Mark Struthers, a fee-only planner with Sona Financial in Chanhassen, wrote this article for NerdWallet.