How to Save for Your Kids' College Education

How to Save for Your Kids' College Education

June 30, 2023

When we talk to our clients about saving for their children’s college education, there is usually a moment when we hear them pause to catch their breath. This usually happens right after we talk about the price tag. According to the CollegeBoard’s most recent Trends in College Pricing report, the average published price of in-state public college tuition, fees, room, board, books and supplies was $24,490 in academic year 2022-23, or roughly $98,000 over 4 years. The average for a private college was $54,670 per year, or nearly $219,000 over 4 years .

The cost of private college tuition has gone up 10-fold since 1980-81, from $3,620 to $39,400 (or "just" 3-fold when adjusted for overall inflation). In-state public school tuition has gone from $800 to $10,940, which is 14-fold for those keeping score (or almost 4-fold when adjusted for inflation).  

At an inflation rate of 3.5%, four years of private college costs could total more than $420,000 by the time a newborn is dropped off at the dorms for the first time. The parents of a newborn would have to save almost $500 per month for 19 years to pay the full price of in-state public college and more than $1,100 per month for private college.

The numbers are daunting. We hope college inflation will continue to slow. That would make the math somewhat less overwhelming. We can’t control college prices, though, so we encourage parents to plan for [close to] the worst and hope for the best.

Establish a goal. It’s highly philosophical but we typically start by asking parents to think about what percentage of their children’s college expenses they want to have saved ahead of time. Do you want to be able to pay 100% of public college costs? Or 100% of private college costs? Or 50%? Or none? There’s no right or wrong answer, but it’s important to ponder this when your kids are young.

Start saving early. We only have roughly 20 years to save for college, which is a relatively short time horizon from an investment perspective. We typically recommend the year-of-enrollment portfolios based on index funds, which are offered in most 529 plans. The year-of-enrollment portfolios start out invested mostly in stocks but gradually reduce stock ownership and increase allocations in bonds and cash as the child approaches college age. The typical average allocation for these portfolios over 19 years is roughly 50% in stocks and 50% in bonds. The sooner you start saving, the longer the money can work for you by accruing and compounding investment returns when stock allocations are relatively high. It’s also worth considering front-end loading the 529, by making up to 5 years of contributions at once. Theoretically, two parents could give each child $170,000, or $34,000 per year over 5 years, without exceeding the $17,000 per year gift tax exclusion (if the parents "split the gift").

Pick a good 529 plan. All 529 plans are sponsored by states, but you don’t have to use the money for college in that state. Therefore, you can shop around. The first question to ask is if your state allows a tax deduction or tax credit for in-state 529 plan contributions and/or out-of-state 529 plan contributions. If a state only grants a deduction for an in-state plan, it likely makes sense to use the in-state plan. If the state has no state income taxes, offers no 529 tax deductions/credits or allows a deduction/credit for out-of-state plans, you can look across the country for great low-cost options like the New York, Utah, and Vanguard/Nevada plans (just to name three; most plans are relatively good). Avoid the advisor-sold plans, which often carry high commissions and fees, and stick to the direct-sold plans.

Ask your extended family to consider 529 gift cards. Many plans accept 529 gift cards, which you can register for, tell family about and have them consider for holiday and birthday presents. Also, some wealthy, generous grandparents could be looking for ways to give money to their family in a tax efficient way. They could set up 529 plans of their own to get the state tax deduction on their contributions.

Take advantage of community college arbitrage. The cost of 2-year public college tuition is often a fraction of 4-year public college tuition and can be great way to knock out general education coursework. Often you can transfer those credits to a 4-year college of your choice. Importantly, nobody will ever know or care where you spent the first 2 years of college when your bachelor’s degree is from a 4-year school.

Consider alternatives. There’s an old joke that college was the best 6 or 7 years of my life. That joke isn’t funny anymore. College is too expensive to meander through without direction or interest. If your kids are not emotionally ready for college, then maybe a gap year or two—focused on service—would be a great way for them to grow and develop. College may not be for everyone, so an apprenticeship or trade school might be a great option too.

At the appropriate time, include your children in the planning process. When your kids are in high school and college becomes less of an abstraction, sit down with them and pull them into the process. “Here’s how much money we’ve saved for you. Here’s how much debt we’ll allow you to take on. Income from a job might be part of the puzzle, Scholarships would sure help. Let’s figure out how we can find a college that’s a good fit for you and affordable for us.”

Paying for your children’s college education is both a philosophical and financial challenge. Set goals, start early and be creative. And, of course, adjust based on your children’s aptitudes and attitudes.