Assessing College Costs
It takes careful planning and a disciplined investment approach to afford the escalating cost of a college education. The College Board now says that it will take over an average of $30,000 per year for four years at a public university; $40,000 or more per year for a private institution. More than one child headed to college puts even greater pressure on this already staggering amount. The best advice is the simplest: start investing for college early…beginning at the birth of the child is not too soon.
Ask yourself these key questions:
When will I need my investment?
Most college freshman will make their first withdrawal from their college fund in August after their 18th birthday.
How much will I need for college?
Identify how much a college education is likely to cost when your child is ready to attend. Target the type of school and estimate the costs for tuition, fees and other expenses. Don’t forget to explore financial aid in the form of government loans, grants and scholarships as an alternative way to fund your child's education.
College Planning Resources
These resources provide valuable information and online tools to help you calculate college costs and plan your approach.
Department of Education
The College Board
College Investment Accounts
There are several types of accounts used to invest for a child’s education. Account ownership and tax-advantages should be considered when choosing which college investment account is right for your situation.
You may establish an investment account in your own name. This approach provides maximum control over how the assets are used. If your child does not go to college, the parent may use the account for any purpose. The downside is taxation, which is at the parent’s rate, not the child’s rate.
Custodial Accounts (UGMA/UTMA)
An adult can establish a "custodial" account in the name of a minor. This is an irrevocable gift and will shift to the child’s control at age of majority, which varies by State. In most cases, gains are taxed at the child's tax rate. Colleges will consider a higher percentage of money held in custodial account than in a parent-owned account when making financial aid eligibility decisions.
These tax-advantaged plans allow the adult to control the account on behalf of the child. Unlike the UGMA/UTMA, the beneficiary may be changed to another member of the beneficiary’s family. There are generally no time or age restrictions on the use of the money.
Contribution limits are high, deductible on most state tax returns, grow tax-deferred and may be withdrawn tax-free. Specifics for these plans vary by state.
There are two types of plans, College Savings Plans and Prepaid Tuition Plans. Because plans are established by each state, investment options, account features and state tax deductibility rules are different.
College Savings Plans
These plans give you more control than Prepaid Tuition Plans, but there is no guarantee your investment will be enough to pay tuition costs. You determine how much to invest, which investment option is best for you and you may spend the plan at any qualified institution of higher learning. Most College Savings Plans offer asset allocation portfolios matched to the child’s age. These age-based portfolios automatically rebalance to reduce risk as the child nears college age.
Prepaid Tuition Plans
In these plans you prepay all or part of tuition costs in today’s dollars and are protected against tuition increases. This plan is beneficial when tuition increases faster than your investment portfolio, but is not best when investment returns out pace tuition increases. These plans may or may not permit you to use the assets for colleges located outside of the state managing the plan.
Education IRA -- 529 Plan
An Education IRA is designed specifically for funding higher education costs. Also referred to as a 529 Plan, these state-sponsored college savings plans allow you to make contributions into an account to pay those future costs. 529 Plans offer tax advantages to both the account owner and the beneficiary since no income taxes are paid on the earnings if the money is withdrawn for qualified educational expenses.
Contributions can be made annually for each child younger than 18. The non-deductible contributions won't be subject to a gift tax, and the accounts will be tax exempt. Distributions that don't exceed amounts spent on education will be tax free, but all or part of the excess not spent on education may be subject to taxes and penalties. Consult with a tax advisor to determine if a 529 Plan is right for you.
Coverdell Education Savings Account (ESA)
These plans work like Roth IRAs. Contributions are non-deductible and your investment grows tax-free. Like 529 plans, the beneficiary may be changed to another family member, or the beneficiary must withdraw the funds by age 30 to avoid penalties. Funds can be used for the child’s educational expenses from grade school to graduate school.
Before investing in an Education IRA, check with your personal financial advisor or tax advisor to examine current rules and how they affect you.
A trust account can stipulate exactly how and when a recipient is to spend the funds. However, trusts can be costly to establish, may require an attorney and may disqualify your child from receiving financial aid.
Ten Tips for Investing for Children
How will you pay for four years or more at the college of their dreams—or the college within your financial reach? It’s going to take planning…so start with these 10 tips.
Start investing when the child is born, and focus on reaching your goal by age 18. While you can start saving for college at any age, the longer time you have to invest, the more aggressive you can be in your approach and the more likely you are to build up the nest egg that you’ll need.
Invest a fixed amount in a mutual fund every single month. Budget it, don’t cancel it, and increase the amount when you can. The added benefit of using this disciplined approach of “dollar cost averaging” is that you don’t have to guess when the market is high or low. You’re buying shares regularly at various prices. Investments funded steadily also benefit from compound growth over time.
Set Your Goal
Based on the child’s age, calculate the amount of money you will need for college. Use an interactive calculator to project college costs. The price of a college education may shock you, but setting a defined goal can help ensure investment success.
Determine How Much You Need to Invest
Break down your goal into annual and then monthly amounts that you will need to invest. That lump sum won’t seem so overwhelming when viewed as a long-term monthly commitment.
Identify Sources of Financial Support
Consider possible inheritances, gifts, student loans, scholarships, trusts…and then disregard them for now. Invest as if this is all there is going to be (but keep your list for later use).
Encourage Investment Gifts
Let grandparents and family members know that a college fund has been set up and contributions are welcome. Grandparents, you can reduce your estate by giving tax-free gifts to your grandchildren and making investments into their college fund.
Look for Low Minimum Investments
When you’re first opening an account, you may not have the full minimum amount required. Find fund companies with low minimums or that waive or reduce initial minimums if you set up regular monthly investments.
Choose Investments for Your Timeframe and Goal
Invest for the long term and select investments that reflect that. Consider the amount of time you have to reach the goal and the level of risk you are willing to take as you evaluate types of mutual funds designed for long-term growth.
Select Low-Cost Investments
Mutual funds are ideal for long-term investments for children and college. Select funds with no sales charges or very low sales charges, low expenses and no excessive fees to ensure that more of your dollars are invested.
Involve the Child in the Process
Let your child know that you are investing for their future. Talk about college, or other life goals they hope to reach. As they are older, explain the value of saving, sacrificing to reach goals and planning. Let them see the results periodically. By helping them understand the saving process and how investments work, much can be learned…including the power of a focused, long-term approach to reaching an important lifetime goal.
College Investment Portfolios
Portfolios College Investment Approaches
These model portfolios are designed to illustrate how you might allocate your investments throughout a child’s life. These are examples, intended to show how you can build investments over time. Every situation is different and other factors such as inheritances and gifts, trusts and family expenses will dictate the approach you are able to choose.
Infant and Toddler Portfolio
Newborn to Age 5
13-20 Years to Save
Maximum Long-term Growth
With time on your side, you have the maximum opportunity to build college assets. Consider selecting investments that offer the greatest potential for long-term growth. While more aggressive investments carry higher levels of risk, your long-term goal focus can work in your favor.
- Set up automatic Monthly Investments now and increase the
amount every year
6-13 Years to Save
Part of your investments should still focus on aggressive growth to build assets. You can reduce risk by diversifying into less volatile choices for conservative growth and income as the child grows older.
- Continue and increase Automatic Monthly Investments
- Monitor investment performance and reduce volatility as you get closer to goal.
1-4 Years to Save
Growth, Income and Capital Preservation
With college within sight, you’ll want to consider more stable income and capital preservation. You’ll also want easy access to the funds when college bills start to arrive. Shift investments from maximum growth into growth and fixed income securities with maturities that match your timeframe for needing the money.
- Continue automatic investing.
- Move some assets into a money market fund that allows online transactions.