September 11, 2008

Our plan for paying for college costs. Who pays? How much?

How much parents contribute for college expenses is a personal choice. Many parents will try to pay 100% of college expenses for any college their children want to attend. Other parents feel that their children should contribute to the cost. Some parents don't feel any obligation at all to pay for college expenses. Whatever your choice is, it should be decided far in advance so you have time to save the amount you as parents will need.

My wife and I have discussed paying for college for our children. We both agree that it is best if the students and parents both contribute to college costs. Our feeling is that it is important for a child in college to have a stake in their own investment in college so they value the cost of the education. The concern is that if they are spending "other peoples money" (Mom and Dads) that they will not value the education they are receiving as much as if they had a personal investment in it.

We also both feel that public colleges are a good value and provide a quality education. If our children want to attend a pricey private school then it will be their responsibility to cover the added expenses.

So our general plan is to pay a portion of our children's college education and there will be a cap on what we contribute. The exact amount we contribute or how we determine it isn't written in stone yet. We've discussed paying only for tuition up to the cost of an in state public school and we've also considered paying 50% of the college costs up to a defined maximum. Given the cost of public schools we're looking at approximately $7000 annual contribution. That should cover either the tuition or 50% of the total costs, whichever way you want to look at it.

However that $7000 per year is in todays dollars. In 18 years the amount will be considerably more. Tuition inflation is more than general inflation. FinAid site has an article on tuition inflation and they have annual inflation rates from 1958 to 2007. From 1958 to 2007 annual increases in college tuition have averaged 6.9%. More recently in the last 20 years from 1988 to 2007 increases have averaged 6.06%. So its reasonable to expect college tuition and fee costs to increase 6-7% annually.

Room and board shouldn't go up quite as fast. Rent and food for college students isn't any different in essence than rent and food for the general population so its inflation rate shouldn't be much different than general inflation rates. Housing and food will probably go up closer to 4-5% annually.

Looking back at what I paid for college and comparing what it costs today I see similar increase rates. I paid around $2400 a year for tuition 17 years ago and the same school now charges about $6800. Thats about 6.3% annual increase for tuition. My room and board was $3600 a year 17 years ago and it would now run $8600 a year. Thats a 5.2% annual increase for room & board.

From the previous article on college costs the rate for public in state tuition is $6,185 annually and the total cost is $13,589. We can use the formula to adjust for inflation to figure the costs in the future. At an annual increase of 6-7% the tuition will be $17,654 to $20,904 annually in 18 years. Over 18 years of 4-5% increases the other expenses will end up $14,999 to $17,818. That would put the total cost for a 4 year public school in 18 years at $32,653 to $38,722.

If we plan on paying for about half of the total costs OR paying for the tuition then we'd be on the hook to cover $16k to $20k in 18 years. Multiplied by 4 that gives us a total of $64k to $80k.

So to sum up, if taking inflation into account, we have to save $64k to 80k per child to partially fund their college.

I plan on using a tax sheltered 529 college savings account to save for college. This will allow our savings to increase without having to pay taxes on the gains. I'm going to use relatively stable and save investment choices to ensure that we get consistent gains. So I'm going to estimate a conservative 6% annual return.

Given our savings goal, how much will we need to put away each year? MSN has a savings calculator. I can use that to estimate my annual savings requirement to hit our goal. Walking through the calculator options: 1) choose the option "How much must I contribute to my savings?" 2) specify :initial balance $0, savings goal $64k or $80k, term 18 years, 3) pick a rate of return of 6% and 4) pick 'no' to indicate the savings aren't taxed. The calculator says that I would need to save $2038 to $2548 a year at 6% return to accumulate $64,000 to $80,000 in 18 years.

That is using a fixed investment figure. However I expect that my ability to save will increase in the future as my pay increases. So it would make sense to gradually increase my savings contributions annually with inflation adjustments. I can better estimate this by using a spreadsheet. I figure that if I start with an annual contribution of $2000 and my contribution increases 3% annually with inflation and I make 6% return then I would be able to accumulate about $80,000 in 18 years.

The bottom line is:
We plan to pay for half of our childrens college at a public 4 year school. To meet this goal we will need to save $2000 a year starting at birth and increase the savings with inflation.

Photo by D'Arcy Norman

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