Choosing a Final Goal
One of the most common ways to set a savings goal is to base it on the expected cost of college. It is helpful to start by using one of the available calculators to estimate the cost of college for your child, based on factors such as your child’s age, the type of school you expect your child to attend, and the expected rise in college costs. You should also consider whether there is a specific school you already know your child wants to attend.
Do you feel a bit shocked? The good news is that whether you are saving for in-state or out-of-state college or private college, you don’t have to plan for the full amount.
Financial advisors may suggest saving between one-third and half of the expected college cost, with the expectation that the remainder will come from financial aid, scholarships, and the current income of the parents and/or student. This can make the college savings goal feel more realistic and achievable.
For example, let’s assume you have a newborn and you are ready to start saving now. To cover one-third of the expected college cost, your final goal might be $44,753 for an in-state public university, $69,346 for an out-of-state public university, or $112,072 for a private university.
Setting a Monthly Goal
Is it hard for you to visualize the final goal years down the line? You might consider breaking it down into a monthly contribution amount. But remember that the way you save will significantly impact the amount you will have saved by the time your child starts college.
Many experts recommend using a 529 college savings plan, which is a tax-advantaged investment account. A 529 plan provides tax-free growth and withdrawals for qualified higher education expenses, including tuition, fees, housing, books, computers, and other qualified education expenses.
What does this mean for you? Choosing a 529 plan can mean a much lower monthly contribution as the money grows over time. With a 529 plan, the appropriate monthly contribution for a child born in 2022 would be about $140 for an in-state public university, $215 for an out-of-state public university, or $350 for a private university.
If you intend to save using a traditional savings account or a taxable investment account, you will need to adjust the monthly contribution accordingly. For example, the average interest rate on savings accounts as of January 2022 is 0.06% APY (annual percentage yield). At 0.06%, you would need to contribute about $230 monthly in a savings account for 18 years to cover one-third of the expected college cost for an in-state public university; about $350 for an out-of-state university; and about $550 monthly for a private university. That is much more than the required savings compared to a 529 plan.
Using a taxable investment account can lead to much better returns on your savings. With an average return of 7%, a monthly contribution of about $115 would cover the expected cost of an in-state public university, $180 for an out-of-state university, or $290 for a private university. However, you would miss out on the tax exemptions on the earnings and gains that a 529 plan provides.
Determining What You Can Afford
Finally, you can set a monthly college savings goal based on what your family can afford. This is a good approach if there isn’t much flexibility in your budget.
Of course, what is reasonable will vary significantly from one family to another. If you are unsure about what your family can afford, try breaking it down using Lumina Foundation’s 10% rule.
Although it was originally intended as a benchmark for colleges seeking to expand access to higher education, families can certainly use this formula. This approach recommends that families pay for college using the following guidelines:
- Affordability
- Families allocate 10% of their discretionary income.
- Families save over a 10-year period.
- Students work 10 hours a week while studying at university.
Discretionary income is typically defined as gross income after taxes, minus all minimum living expenses such as food, medicine, housing, utilities, insurance, transportation, etc.
However, the Lumina Foundation notes that for the purposes of these standards, any income exceeding 200% of the federal poverty level is considered “discretionary.” For a family of four in 2022, any income above $55,500 would be considered “discretionary.”
Using this formula, a family earning an average of $100,000 annually may save 10% of the remaining $44,500, which amounts to $445 per month. Over 10 years, they will save more than $53,000 for college. With the student working 10 hours a week for 50 weeks a year at the current minimum wage of $7.25 an hour, there will be an additional contribution of $3,625, making the total contribution $14,500 over four years.
Of course, if your income increases or decreases, contributions can be adjusted accordingly. You can always take this approach further by using a tax-advantaged savings tool to enhance the growth of your money over time.
For example, if a family with an 8-year-old child starts saving $445 a month in a 529 savings plan, this amount would be enough to cover about one-third of the cost recommended by experts for a public out-of-state university, or about half the cost of in-state college.
Conclusion
When it comes to paying for college, starting early is best. But getting started can be overwhelming. College prices are rising – college costs have increased at a faster rate than a basket of general goods and services that people typically purchase since 1980 – and there are many other unknowns to plan for. Should you choose a public or private university? Should you stay in-state or go out-of-state? Can your child earn scholarships? What about graduate school?
Fortunately, you don’t have to know the answers to all these questions to start saving. Here are some strategies to determine how much to save for college.
The first step in saving for college is to determine how much you want to contribute to your child’s education: a percentage, a dollar amount, or the total college costs. There are three main strategies for saving for your child’s education: planning to reach a final balance, breaking down savings into monthly contributions, or contributing a percentage of your discretionary income. Allocating a percentage of your discretionary income monthly is best for families with tight budgets.
Choosing a final goal is one of the most common ways to define a savings target, based on the expected cost of college. It is helpful to start by using one of the available calculators to estimate your child’s college costs, based on factors such as your child’s age, the type of school you expect your child to attend, and the anticipated increase in college costs. You should also consider whether there is a specific school that you already know your child wants to attend.
Feeling a bit overwhelmed? The good news is that whether you’re saving for in-state, out-of-state, or private college, you don’t have to plan for the entire amount. Financial advisors often suggest saving between one-third and one-half of the college cost, expecting the remainder to come from financial aid, scholarships, current income from parents and/or the student. This can make the college saving goal feel more realistic and attainable.
As
For example, let’s assume you have a new baby and you’re ready to start saving now. In order to cover one-third of the expected college costs, your ultimate goal might be $44,753 for an in-state public university, $69,346 for an out-of-state public university, or $112,072 for a private university.
Is it hard for you to envision the ultimate goal years down the line? You might consider converting it into a monthly contribution amount. But remember that how you save will greatly affect the amount you will have saved by the time your child starts college.
Many experts recommend using a 529 college savings plan, which is an investment account designed specifically for saving for college.
Source: https://www.thebalancemoney.com/deciding-how-much-to-save-for-college-4151683
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