The amount of student loan debt in the US is jaw-dropping and our economy is beginning to see the crippling effect of the cost of higher education. As of June 2017, the cumulative student loan balance stood at about $1.34 trillion, a figure that has doubled in the last decade.
The debt of paying for college has far-reaching implications and is a threat to the financial freedom of students and their families. A recent study shows that 31 percent of baby boomers are unable to save for retirement due to student loan debt. In this same study, 36 percent of Millennials are unable to purchase a home due to student loan debt. There aren’t any hard numbers for Generation Z (yet), but the rise in education costs and massive increase in debt indicates that the student loan crisis will get worse before it gets better.
Finding a way to pay for higher education is a problem that most parents must confront. Over the past 9 years, I have helped clients save for their children’s college tuition and expenses. My daughter was born last year. Having gone through the steps of planning for my daughter’s education, I thought it would be helpful to share my experience and expertise about education savings strategies.
This article was written as a guide to understanding the basics of preparing for education expenses. Typically, when I refer to education expenses, I mean college funding for a 4-year university, however, this advice also applies to private K-12 or post-graduate study. The information I am sharing is relevant to parents, grandparents, or any other committed relatives or individuals looking to contribute to a savings strategy for a child’s education.
Step 1: Know Your Goals and Objectives
The first thing to do is to know the goals and objectives for your education funding. This includes the education goal of the student, what school the student plans to attend, and the projected amount your family can afford to cover.
Having a clear idea of the level of education the child will pursue is critical. The cost differential between an associate degree and a doctorate could be several hundred thousand dollars. It will be difficult in a child’s younger years to determine something so far in the future; the safest course is to plan for a four-year degree and then to adjust as needed going forward.
Location, location, location:
The next thing to consider is where your child will attend. Columbia University is one of the most expensive universities in the U.S. at almost $60,000 a year for a four-year program. A local community college, state college, or other institution might charge as little as $8,000 a year. Having a good idea of where the child will attend college removes much of the guesswork from estimating tuition expenses.
Splitting the bill:
The next target you’ll want to figure out is how much of the expense you’re comfortable covering. Do you plan on paying 100 percent of the overall cost? Or maybe you can only afford 75 percent, 50 percent, or some other figure? The amount you’ll need to save will change significantly if you’d like to pay for half the expense versus the entire expense of a similar university. Understanding your savings goals and objectives will allow you to better understand and create a savings plan for future college costs.
Step 2: Consider how to Fund Future College Expenses
The next thing to consider is how, as in, how do you fund a potential $200,000 education expense? There are basically three primary ways to pay for education expenses: loans, scholarships or grants, or a savings strategy.
Student loans are one way to pay for future expenses, but I find they are best suited to supplement education expenses, not the primary funding mechanism. Loans require paying interest, and although this is an investment in the student, it’s not always wise to take on debt. These loans can come from federal agencies, private institutions, or other sponsoring organizations.
Over 8 million Americans have stopped paying on their federal student loans. Student loan debt has become so extreme that some Americans have resorted to fleeing the country in a desperate attempt to escape suffocating debt. Make sure you and your child are well educated on the impact of student loan debt.
Scholarships and grants:
Scholarships and grants have two categories: merit-based or need-based. If you have an exceptionally smart or athletically gifted student who can earn a scholarship, then you are the lucky ones. However, most students must go through the rigorous process of applying for the thousands of scholarships or grants available to them.
It’s one thing to look at your three-year-old and dream of their achievements as an athlete or elite scholar, but it’s a risky gamble to assume that your dreams or hopes will translate into paying your child’s tuition through a full-ride scholarship. If you are planning early, hope for scholarships and grants, but have a backup plan.
Having a savings strategy:
A savings strategy takes the form of planned, periodic contributions to a savings account. Being consistent about saving will have the greatest impact on reaching your funding goal. There are many programs available that deduct funds from your bank account and allow you to increase your contributions over time. There are several ways to fund education costs, so take the time to understand what’s available to you and your family.
Step 3: Know Where to Efficiently Save
Saving for education expenses is a wise choice, and you need to determine the most efficient savings vehicle. There are many options, and each has strengths and weaknesses.
You might consider using a 529 plan, a Roth IRA, a Uniform Trust/Gift to Minors Act account (UTMA/UGMA), or a Coverdell Education Savings Account. You can even use life insurance to fund future education expenses. Each of these savings options has different benefits and pitfalls and knowing the best approach will greatly impact your savings strategy.
What to look for in a savings plan
Things to study are tax advantages, savings options, and the flexibility of the plan. When considering tax advantages, you may ask yourself, “does this account allow tax efficient savings strategies?” For savings options, you should evaluate the investment choices available. In some cases, there are limitations on investment categories for specific accounts.
And lastly, you’ll want to consider the flexibility of the account. This means you should gauge the transferability and usability of the funds for education-related expenses. Knowing where to efficiently and effectively save can help your family significantly reduce the strain of funding college expenses.
Step 4: Understand the Cost of Waiting
The last thing to consider is the cost of waiting. Every year you put off saving for a child’s education expenses will require significant effort to catch-up. Education costs are rapidly increasing due to inflation.
My daughter just turned one, and I am concerned about paying for her college. A school like the University of Colorado-Boulder, which costs about $26,000 per year today, may cost over $55,000 per year in 17 years when my daughter begins her freshman year at Boulder (yes, we’re hoping she’s a Buff like Mom and Dad). We can cover the full cost of tuition by investing $609 per month, but if we wait one year that number jumps to $670 per month. So, it pays to not to procrastinate. Knowing what the savings goal is will help determine how much you will need to set aside each month or year to achieve your goal.
These are the four steps to better understanding how to plan and save for education expenses. Saving for education expenses can provide your family with better funding options, more flexibility, and reduce the burden of debt. Before you begin the process of saving for education please take the time to understand your goals and objectives, your saving strategy, and the efficiency of the account you are saving in. A terrific option for saving is through a 529 plan.
A 529 Plan is Often the Best Choice for Coloradans
The government has set up great options to allow parents, individuals, and families to efficiently save for education expenses. One of the best saving vehicles is a 529 plan. 529 plans are state-specific and provide tax-deferred growth and tax-free distributions for qualified education expenses.
The Colorado 529 plan allows a tax deduction for the annual contributions with no income limit. Folks looking to reduce tax liability will find tax-mitigation options through a 529 plan.
Broad investment options:
Another great advantage of a 529 plan is the access to investment options. Instead of setting the aside money in a savings account earning very little interest, you can select a wide array of investment options. These options might include direct investment in the stock market, or taking less risk using bonds. Having a financial professional help guide these decisions may be a great way to build your education savings fund.
You can make changes as needed:
A 529 plan offers significant flexibility on who can use the money. For example, if you have saved in a 529 account earmarked for one child but find out that she earns a full athletic scholarship to her favorite university, you can divert those funds to another one of your children. Money can also be diverted and gifted to a niece, grandchild, cousin or another relative. You can even use the funds for your own education. And if it turns out that the money is not needed for education, you can withdraw the funds and simply pay taxes on any gains that may have occurred.
Still Not Sure Where to Start?
Saving for college expenses can be challenging, but if you start early and save often then you may be able to achieve your goal of funding college education expense. When picking your savings vehicle to consider the tax benefits, the investment choices, and the flexibility of the plan. If you would like to discuss options for your situation and receive a comprehensive Colorado 529 analysis, contact me for a free appointment.