Funding Your Child's College Education
Overview
We all know in today’s world how important a college education is to a student. A bachelor’s degree is worth about $900,000 more in lifetime earnings over a high school diploma. A Masters’ degree or law degree can add significantly more (a lawyer can expect to make $3.2 million more than a high school grad, and an MBA, $1.5 million more).
Cost of College
Now more than ever, a college degree and/or graduate degree is important, but the cost of college has skyrocketed. College costs have increased between 4 and 6% in the last 20 years. Four years of public university in Michigan is about $65,000-$90,000, including living expenses. If you are looking at college costs for a 2 year old, that price tag would be $175,000. The trick to college funding is to save now and save right.
How Much to Save?
The first question for most parents (or grandparents) is how much to save? Unlike retirement planning, college is actually a reasonably simple calculation: you know when they are going, probably, you know how long they are going (add a year), and you probably know how much you want to cover. For example, our managing partner has agreed with his kids to pay 75% of their college through undergrad (none are in grad school yet, so we’ll ask him that later). Suppose he wants to cover 5 years of an in state public school for his 13 year old. If he hadn’t saved anything (he has, but let’s make it a good example), he’d need to save around $650 a month and continue spending $650 a month through college. Suppose we had some generous grandparents wanting to help fund the newborn granddaughter’s college; they’d probably need to fund about $260 a month (we’re assuming a public school, inflation at 4%, funding to a 75% goal with 8% return on investments; your mileage may vary).
Where to Save... 529 Plans?
The next question is where to save? There are a variety of choices, but let’s start with the best option first: the 529 Plan. A 529 Plan is a tax-free vehicle to save for college. The parent or grandparent puts away after-tax money, and the growth is tax-free if the beneficiary uses the funds for any education expenses. The term ‘any education expense’ is pretty broad and includes tuition and fees, of course, but also room and board, computers, food, travel, etc. In addition you can transfer 529 plans between beneficiaries, so if one child or grandchild doesn’t go to college, you can move it to another, and so on.
Where to Save... Coverdell ESAs?
Coverdell ESAs are like 529s, except you can use the tax-free proceeds to pay for public or private K-12 education and college. Coverdell contributions are limited to $2,000 a year, and subject to income limitations (529 contributions are not subject to income limits.)
Where to Save... custodial accounts?
An older way, and less preferable, is a custodial account (like a UGMA or UTMA). In these, the student actually owns the money (bad for financial aid), and in addition, can get their hands on it sometimes as soon as 18. Worse, the parents can be taxed on the income from a custodial account.
Where to Save... in the parent's name?
A final method is to just save the money in the parent’s name and earmark it for the kiddos. We’ve created municipal bond portfolios where the grandparents would create a ladder of bonds that mature as the grandkids go to school: $5,000 in the first semester, $5,000 in the second, and so on.
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