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.
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: Room and board, which accounts for a large portion of the cost of attendance, is one area where you can save money by having your child live at home for the first year or two.
- Inflation: According to the College Board’s recent study, prices increased by about 3% from the 2014-15 school year to the 2015-16 school year. It’s best to err on the side of caution and choose a relatively high rate of inflation — say, 5% — 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. Planning on a 20% to 25% discount is often reasonable.
- Your child’s contribution: Many parents believe that their children should help pay for school through work or student loans. If you decide to have your child contribute, make sure he or she is aware of the risk and burden involved in taking on debt.
- Family contributions: Talk to your family to find out whether this is something they are interested in or able to do.
Magic number example
To see how all 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 2016-17 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% 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).
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% 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% over 19 years, or $42,850 x (1+0.05)19 = $108,280.
With a 7% rate of return on their college savings (a reasonable assumption based on historic Standard & Poor’s 500 index returns and a 70% to 80% equity portfolio), it will require saving $228 per month to reach their goal of $108,280 in 19 years. For a middle-class family like the Johnstons, it is difficult, but doable.
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.
Of course, 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.
Unless you have unlimited resources for college, you should set up a reasonable plan for savings, make periodic adjustments and make the most of what you have.