The Economics of College
If you hope your newborn is Harvard material, you’d better start saving – as much as $1,200 a month.
Want to send your child to a public university like UC Berkeley? You still need to set aside nearly $700 a month to be able to afford the cost of college 18 years from now.
By most estimates, the price of higher education will rise on average between 5 and 7 percent a year. That means that by the time your baby leaves the nest, four years at UC Berkeley could cost more than $350,000.
If that causes some sticker shock, you’re not alone. And it’s why financial advisers recommend that parents begin putting away some cash into a 529 college savings plan as soon as possible.
With a 529 plan, parents invest their money in an account that grows tax-free until the child needs it for college. Unlike most other savings and investment vehicles, all the gains that are made during that time are not taxed, allowing parents to save more money, faster. Each parent – as well as each grandparent – can invest up to $13,000 a year tax-free. You can also jumpstart your child’s college savings plan by investing five years’ worth at once.
“A college education is one of the most important investments you can make in your lifetime,” says Ed Christiansen, a financial adviser for Merril Lynch in Walnut Creek. “The 529 plan is a college planning road map with significant tax advantages.”
How to pick a savings plan
Going about selecting one can be daunting, though. Each state offers a 529 college savings plan, and each with a number of options. Some states offer tax benefits if parents pick their state’s plan, but that’s not the case in California.
Paul Andrus, a financial services representative with New York Life in Fremont, recommends that parents begin by calculating how much they think they need to save and determining how risky they’re willing to be with their money. “It is overwhelming,” he says. “So what do you do? You take it one step at a time.”
Factors that parents should weigh include the fees and expenses associated with the plan and how flexible it is. Does it offer enough options for different kinds of investors?
It’s also important not to look just at how well the fund has performed, since that doesn’t necessarily predict how well it will do in the future, says Greg Brown, a mutual fund analyst for Morningstar. While performance is a factor that Morningstar weighs, Morningstar also examines the program’s underlying strategy, the associated fees, its flexibility and its resources.
One of the plans on the worst list, for instance, was the New Jersey Best 529 College Savings Plan, which was criticized for having high fees and being too aggressive in how it allocated its funds. On the best list, meanwhile, was Virginia Education Savings Trust, which it lauded for having a diverse portfolio and low fees.
One popular recommendation is to pick an age-based plan, which many states offer and which adjusts as the child grows older. When the child is young, it’s more risky, with a large percentage of the money invested in equity funds. But as the child enters middle and high school, it becomes more conservative, with a larger percentage in bonds.
School (savings) rules
There are rules, of course. It must be used for higher education purposes such as tuition, room and board, and books. Apply the funds to something else and you could incur a penalty and the money could be taxed. While it can be used for a variety of institutions, including trade schools, it doesn’t cover many international schools.
At the same time, you don’t have to worry that the money is saved in one state and your child is going to school in another. And if the eldest child wins a scholarship, the unused funds can be passed on to a sibling.
As the still-fresh-in-our-minds stock market crash demonstrates, it can come with some risks. Parents who had put money largely in stock funds likely saw their investments flounder last year. Then again, financial advisers say parents who invest now stand to benefit, scooping up stock at low prices and giving them time to mature.
The good news is you aren’t locked into one plan forever. If you are not satisfied with your initial pick, you can roll over the funds into a different plan. If the stock market still leaves you jittery, you can opt for a more conservative plan with mostly bonds instead.
“It’s more important just to start saving, regardless of which plan you choose,” says Joe Hurley, founder of SavingforCollege.com. “It’s more important to start putting that money away.”
Ellen Lee is a San Francisco-based freelance writer and the mother of a 1-year-old daughter.
How to Save
IF YOUR CHILD IS A NEWBORN
This period is the best time to start investing, since you have the longest amount of time for your money to grow. Financial advisers tend to steer parents of young children to invest a greater percentage of their money in stock funds, which are riskier but also make more money over time.
IF YOUR CHILD IS IN KINDERGARDEN
With more than 10 years to go before college, parents can still afford to take risks in how they allocate their dollars. That’s because the market tends to cycle, so they can still maximize their money during that time, says Eric J. Schneider, a financial consultant for Charles Schwab in San Francisco.
IF YOUR CHILD IS IN MIDDLE SCHOOL
As the child nears college age, it’s time to shift the money into more conservative investments such as government bonds. Though they generally don’t make as much money as stocks, bonds also aren’t money losers. And if you haven’t yet started a college savings plan, it’s not too late. Even if your child is about to start college, remember that the money can be used through the four – or more – years of undergraduate school. It can also be applied to graduate studies. “There’s never a bad time to start,” Schneider said.