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Savings Alone Won't Pay for College

May 30, 2018

A college diploma opens the door to a lifetime of higher earnings. Based on Bureau of Labor Statistics, in 2016 dollars, Bachelor's degree holders earn nearly $1 million more over a lifetime than those who have only a high school diploma. Those with professional degrees earn over $2 million more. In addition, college graduates enjoy much better job security and opportunity, especially during economic downturns. Based on "The State of Entry-Level Employment in the U.S. March 2017" by The Rockefeller Foundation, seven in ten U.S. employers look for college degrees when hiring entry-level workers.

For many parents, college is one of life's most important, and expensive, investment goals. How much does it cost? How much can you expect from financial aid? How can you invest and earn more while borrowing less? I would like to answer these questions here and provide some strategies for successful investing.

  1. Understand the costs. College costs are high today and will likely be even higher when your children attend college. Use this chart to estimate future costs and begin creating your investment plan. Simply find a child's current age to see projected four-year costs at both public and private universities. Next, work with your financial advisor to determine how much you plan to pay yourself and how much might come from financial aid, student income and other funding sources. For example, for a 12-year-old, total costs are expected to be about $120,000 at a four-year public college and $271,000 for a private college by the time they enroll. Most parents I know want to pay at least 50% of the costs so that students do not end up with a high student loan balance while trying to enter the workforce after college.
  2. Know what to expect from financial aid. Many families expect more free financial aid than they are likely to receive. Less than half of all students actually get grants and scholarships, and only 0.3% receive enough for a free ride to college. Even if your child qualifies, the average grant covers only 13% of the costs at a four-year public university, while the average scholarship covers just 18%.

    If you earn $150,000 in income and have $100,000 in savings (excluding primary resident and retirement accounts), your estimated EFC (Expected Family Contribution) is $33,737. If your child attends a college that has total annual costs of $25,000, then your child would not qualify for any financial aid as your EFC is greater than the college total costs. If you earn $250,000 annual income and have $300,000 of savings, then your estimated EFC is $80,088 that is more than the costs of going to Harvard ($67,580 per year for tuition, room, board, and fees combined) - not going to qualify for financial aid. 

    It's a common myth that investing for college will hurt your chances for financial aid. The fact is, family income counts much more than assets (in the parent's name) in the formula for awarding federal aid. The maximum parental savings considered in the federal financial aid formulas is 5.64%, much lower than the parent's income (22% - 47% of AGI above the protected amount depending on a number of factors, including household size and number of students in college). Therefore, don't stop saving for college simply because of worrying about missing any financial aid!

    When an account is owned by the parents, it has much less impact on federal financial aid eligibility than custodial accounts or other student-owned assets.
  3. Don't just save, invest. Put the power of compounding to work for you. The sooner you start and the longer you invest, the more time your college fund may have to compound and grow in value. For example, if you start contributing $500 a month when your child is born instead of waiting until age 6, you would accumulate nearly $87,000 more (assuming a 6% annualized return). 

    Make college investing part of your monthly budget. "Pay yourself first" is the principle of budgeting. You can add your pay raises, bonuses, tax refunds and gifts from family members to the college fund. Every small addition could make a big difference over time. 

    Regular savings accounts earn minimal interest. Cash has historically underperformed tuition inflation. Instead of just saving, investing that cash gives you the higher return potential needed to grow college funds and keep pace with rising costs.

    Investing in a diversified portfolio (allocated among stocks, bonds and cash) over time is likely to outpace bond returns and tuition inflation, with lower volatility than stocks.
  4. Tax-efficient investing for education. Taxes can erode investment returns if you invest your college savings in a taxable account (regular brokerage account that does not have the tax advantage of a 529 plan). With a 529 plan, investment earnings and withdrawals are completely tax free when used to pay qualified higher education expenses (including tuition & fees, room & board, books & supplies, computer & related equipment). The recent tax law changes allow people to use 529 plan money to pay for K-12 private school expenses up to $10,000 per year.

    You use after-tax dollars to invest in a 529 plan - you do not reduce current income taxes on federal tax returns, but you also don't need to report earnings each year on tax returns. Many states offer additional tax incentives to contribute to their own state 529 plans. In 2017, Minnesota started to allow tax deductions or credit for contributions to any 529 plans in the U.S. Therefore, Minnesotans can choose other states' 529 plans to get the same tax benefits. However, the credit of $500 is subject to income limitation. For married couples filing joint returns, $500 is the maximum credit if income is federal adjusted gross income (AGI) is below $75,000 and maximum credit is $250 for income between $100,001 to $135,000. The maximum credit is fully phased out when AGI reaches $160,000. Minnesota additionally offers a subtraction for contributions to any state's section 529 plan. A taxpayer may subtract up to $1,500 ($3,000 for married joint filers) of contributions to any state's 529 plan or prepaid tuition plan. Any taxpayer who makes a qualifying contribution may claim the subtraction, without regard to their income.

    529 plans have no income or age limits. You can invest for any child or adult planning to attend college in any state.
  5. Balancing financial aid and retirement savings. According to The College Solution,, 2015, average parental debt at college graduation is $30,867. The monthly loan payment is $358 assuming a 7% interest rate and 10-year repayment period. Total costs with interest is $43,007. Parent borrowers often spend their critical pre-retirement years paying off college loans instead of funding their own retirement accounts. This $43,007 could potentially grow to $142,362 (6% annual return, compounded monthly) in 20 years if this money were invested for retirement instead.

    Keep the education funding goal and retirement goal separate as you decide how much to save. As students can borrow, work part-time jobs and apply for grants, you should not jeopardize your retirement security to withdraw money from your retirement accounts to pay for college. Withdrawing from your retirement accounts such as IRA and 401(k) can trigger a 10% penalty, if under age 59.5, in addition to paying income taxes. Therefore, open a 529 account for each child to start investing now while saving for your own retirement by utilizing a 401(k) plan, IRA, Roth IRA and taxable accounts.

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