Paying For College: Funding the Higher Costs of Higher Education

February 10, 2020 Author: Tess Downing, MBA, CFP®, Complete View Financial

Complete View Financial

Children aren’t cheap. This will not be news to anyone who has children, and even those contemplating starting a family know this — one of the reasons that Millennials have as a group been starting families later. The actual estimated cost, courtesy of the U.S. Department of Agriculture, is $233,610 from birth to age 18. That is a national average, so in some areas of the country the cost is even higher: $264,090 in the urban Northeast and $245,460 in the urban West.

To repeat, that is the cost up to age 18, which means paying for college is not included. For the 2018-19 academic year, the average cost per year was, according to the College Board,

  • $21,370 for in-state tuition at a public university;

  • $37,430 for out-of-state tuition; and

  • $48,510 at a private institution.

Just to emphasize, those numbers are for one year…and they continue to rise.

Whether college is right for your child is a complex question that would require a separate and involved discussion. For now, we’ll assume that’s the path you’ve chosen and focus on how to pay for a college education.

Ways to Save

The most popular vehicle is the Section 529 plan. These have their origins in a prepaid tuition plan established by Michigan in 1986. Because investment proceeds from the plan were taxable, Michigan requested relief from the IRS. This led to a four-year court battle that on appeal ended in Michigan’s favor. More importantly, it prompted Congress to provide tax exemption for college savings vehicles. Section 529 was added to the Internal Revenue Code as part of the Small Business Protection Act of 1996 and subsequently tweaked (favorably for taxpayers in all cases) in 1997, 2001, 2006, and 2007.

There are actually two forms of 529 plans: prepaid tuition plans and 529 savings plans. Every state (and D.C.) has a 529 savings plan. Eleven states (VA, MD, MA, MS, FL, WA, MI, NV, IL, PA, TX) offer prepaid tuition plans. Contributions to prepaid plans are essentially purchases of credits against future tuition costs that are locked in at current levels. Prepaid plans tend to have much less flexibility, since they typically apply to in-state tuition at public institutions only in that state. There are also more limits on uses of plan funds and beneficiary changes. The only real advantage these plans have is that tuition costs are frozen at current levels, meaning college costs will be lower and so smaller contributions are needed (especially considering that tuition inflation rates have been running 7% to 8%).

529 savings plans are similar in many ways to 401(k) plans. The main difference is that 529 contributions are post-tax (as with a Roth IRA), but withdrawals are tax-free as long as the funds are used for “qualified education expenses.” Also, other family members besides the parents can contribute to a 529.

Two other options for college savings include the Coverdell Education Savings Account (ESA) and Uniform Gifts to Minors Act/Uniform Transfers to Minors Act (UGMA/UTMA) accounts. These have some significant limitations (contribution limits in the case of the ESA, for example) or tax complications, but they can certainly be employed alongside a 529 plan.

How Much Do You Need To Pay For College?

If you have the psychic-level foresight to know exactly how much college will cost for your child, your ability to rake in money in the stock market will make paying for it a non-issue. For the rest of us, we have to estimate as best we can. As previously mentioned, tuition inflation has been running around 7.5%. Frankly, the limit most people will run into first is how much they can contribute toward a 529 plan.

For example, if your child was born in early 2020 and plans to attend a public in-state university when he or she reaches the age of 18, you would need to save roughly $600 per month in a 529 to fully fund 4 years of university.

As we explained, prepaid plans make tuition costs predictable, but tuition and fees aren’t the only costs of college. Most prepaid plans cover only tuition, though some also include room and board. Of course, they narrow your child’s options to a particular state’s public universities, which can become a real challenge should your child decide they want to attend school in one of the other 49 states.

Keep in mind that other sources of college funding will or may be available, the main ones being financial aid, student loans, and scholarships. Your child will also have the option to work while in school and/or during summer breaks. For those who qualify and have the desire, military service can pay for college assuming the child is willing to defer starting school. Alternatively, service in a state’s Army or Air National Guard will provide G.I. Bill funds, and in some states, exemption from tuition at that state’s public universities without the need to delay starting by more than a semester or two.

Skin in the Game

Ben Stein, who is best known as the dry-as-dust economics teacher in Ferris Bueller’s Day Off but is actually an economist and attorney (and former presidential speechwriter) in addition to being an actor and humorist, offers this perspective to parents who are considering paying for their child’s entire college education: A college education is an economic asset that will generate income throughout that child’s life. Would you as a parent simply hand over an established and operating business to your child for them to run and make their living? The principle is the same.

Stein (and others) also point out that you should not neglect your own savings and retirement in order to save for your child’s college education — especially considering that not every child will ultimately attend (or finish) college — unless you are expecting them to support you in your retirement.

There are many complexities associated with college savings options ranging from contribution and account limits to variations in 529 plans from state to state to the tax effects of UGMA/UGTA accounts. You should definitely seek professional financial advice when you’re ready to construct a college savings plan for your child. Our best advice is, just as with retirement planning and investing, to start early.

Follow these tips for more college savings ideas.