Intro to College Savings - Lesson 1

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How much to save for college?

If you're like most parents, you know that you should be putting away some money for your children's future college education. Let's discuss the reasons for saving and how much to save.

Why save?

Having funds saved up and set aside for college helps ensure that your child attends the institution best suited for him or her while avoiding a financial burden. Obviously, most families will not have enough money saved up to pay for the full cost of a college degree and must use other options. What are these options, and how do they compare to saving?

1. Your child might seek out grants and scholarships.
2. Your child might take out loans to pay for college. Federal "Stafford" loans are available to all full-time students at accredited institutions, regardless of financial need.
   1. Disadvantage: Federal Stafford loans are limited in amount. They likely will not cover the full cost of college.
   2. Caution: Students taking federal loans may have trouble repaying the debt after leaving college. Defaulting on a federal loan can have serious consequences.
   3. Disadvantage: The total dollar outlay of paying for college with debt is much higher than paying for college with savings. Use our "529 Savings Vs. Loans Calculator" to see how this works.
3. You (the parents) might take out federal loans or a home equity loan to pay for your child's college.
   1. Disadvantage: You may not qualify. Federal parent (PLUS) loans require that you be creditworthy, and home equity loans require that you have equity in your home AND be creditworthy.
   2. Disadvantage: You may be paying high interest rates.
4. You might use the current income from your job or business, along with income your child earns while attending college, to pay the bills. In order to free up enough income, you may be able to cut back on other expenses, like vacations.
   1. Caution: It may turn out that your and your child's income is simply not sufficient to pay for college. What happens if you count on future income, but suffer a job loss or incur medical costs?
5. You might tap your retirement accounts (IRA, 401(k), etc.) to pay for college.
   1. Disadvantage: You might trigger tax and penalty. Early withdrawal penalties on an IRA are waived when incurring qualified higher education expenses, but any associated income tax is not waived.
   2. Caution: IRA withdrawals can severely impact financial aid eligibility in the following year as the entire amount withdrawn—even if tax-free—must be added back to base year income on the financial aid application (FAFSA).
   3. Disadvantage: Your 401(k) can be used for college only when taken out as a 401(k) loan. The loan generally must be paid back within 5 years.
   4. Disadvantage: Using money from your retirement account to pay for college means it will not be there for your retirement.
6. You might ask the grandparents or your friends and other relatives to help pay for college.
   1. Disadvantages: Many parents are reluctant to ask others for direct financial assistance. Also, be sure to understand the potential financial-aid and gift-tax pitfalls associated with contributions or payments coming from others.

In spite of all these possible ways to pay for college, having savings set aside is your best option. It means less debt placed on your or your child’s shoulders, and less reliance on others.

How much should you be saving for college?

The best and easiest way to begin the process is by using an online college cost calculator to establish a college savings goal and determine how much in monthly contributions will be required to reach that goal. Go to Savingforcollege.com’s World's Simplest College Cost Calculator.

A precise calculation would require that you know the following data:

1. The current cost of the institution your child is most likely to attend.
2. The annual rate of increase in future costs at that institution.
3. How much your child will receive in scholarships, grandparent assistance, or other grant money.

Source: The College Board, Trends in College Pricing 2014

Of course, without a crystal ball you cannot know exactly how much your child’s future college education will cost. For this reason, you may want to use the following general rule of thumb: target enough savings to pay for approximately one year at the average private college or two years at the average public 4-year university. For newborns, this approach would suggest monthly savings of between $225 and $250 per month. For a child entering seventh grade with no college savings, the monthly savings goal is between $375 and $415 per month.

Coming up:

Lesson 2: Compare your options

Lesson 3: Shop for a plan

Lesson 4: Get family and friends involved

Lesson 5: How will my savings affect financial aid?