How should I save for my kids’ college?

If you are a parent and living in a country that does not offer free public college (undergrad) for kids, then you are probably thinking hard about this and wondering how best to do this? If you have already figured this out and feel like you are in a good spot, then you don’t really need to read this. On the other hand, if you are still trying to understand this better, read on. While a lot of the specifics I am going to talk about are most relevant to the US, some of the concepts and ideas are relevant to any place in the world. 

Before we go deep into this, there are 2 things I want to get out of the way.

One, I know there is a philosophical debate around whether college is even worth it. Honestly I don’t have a clue how things will look 10+ years from now but from where I sit as of today, I still believe a college education is worth it. But not all degrees are created equal – certainly not from an ROI (return on investment) standpoint – I am not going to go into any of that there. If you have decided you wish to save for college, then you can continue reading this article. 

Two, there is a lot of debate and consternation as to where saving for college comes in the list of priorities? Meaning, all of us have multiple priorities – saving for retirement, saving for college, saving for a house, and many other things. The question I get is how do I do it all? I dont have the money to do it all. What I would say is once you have done the basics – getting an emergency fund, meeting at least your company match on 401K, paying off high interest debt – then after that, my opinion is you can do a bit of everything. Now, different people may have different philosophies on this. What I will say is this – don’t completely ignore your retirement by saving for college. I come from India and culturally Indian parents believe it’s their fundamental duty to help their children before anything else. My perspectives have become more nuanced as I have immigrated to the US – I think we need to definitely ensure our retirement is secure before we save for the kids’ college (the airline analogy where they tell in the event of an emergency you first wear your oxygen mask before you put it on for your children 🙂 but if you wait too long, then you will not have enough saved for college. My wife and I have been fortunate where we have not necessarily had to make trade-offs here but I recognize not all families are fortunate like us. 

With that out of the way, let’s dive right in. 

Begin with the end in mind

My readers have heard me say this many times before. For any goal, begin with the end in mind. In this case, the end game is college (in most places and for most degrees it’s 4 years of college). So if you are in the US, you need to define this with a $ amount. How do you go about doing that?

1. How old is your child and so how many years from now will he/she go to college? That should help you estimate in a certain time frame, the cost of public or private college. In the US, college costs have unfortunately been rising at double the rate of inflation. In the above infographic, I have assumed a 3% growth rate but some may argue its much higher than that. There are calculators online that can also help you estimate this based on your own inputs. (https://vanguard.wealthmsi.com/collcost.php).
2. What % of college expenses are you looking to cover? Are you looking to cover 100%, 70%, 50% or something even lower? 
3. Finally, what kind of university do you want to estimate for? Public, private, community college? 

The answers to the above 3 questions will help determine the $ number to target. My kids are 9 and 5. So I am going to need to budget for 8 years of college between both kids  between 9 and 17 years from now. My goal for them is to graduate without any student loans but at the same time, I don’t want to pay for all of it. Not because I may not be able to afford it but because I want them to have some skin in the game and earn some money during college to cover all or some of their living expenses. Finally, seeing the stark differences in costs between in-state vs out of state and public vs private universities simply shocked me. We have some really good public universities in the state I live in, so my thinking is that unless there is a really compelling reason (which goes beyond reasons like “my friends are going there”, “Oh the campus looks so beautiful”), I intend to strongly encourage my kids to go to in-state public universities. But in my time as a parent, I have learnt one thing – when it comes to kids, there is only so much I can plan. They are going to have a mind of their own and make decisions that I might not have choices in. So while I have very bravely and publicly stated my intent and desire, things might end up very differently 🙂

What is the best way to save?

So now that you have a target number in mind, it’s time to get into the nuts and bolts of how you go about saving the money. At the heart of it, it comes down to putting money aside on a regular cadence that is specifically allocated for college. You could decide that your goal is to save $200K per child and start putting aside money the day the child was born. So you could literally set aside $11,111 each year for 18 years in a savings account (translates to $925 a month). But that’s not necessarily the smartest or most efficient way to do it. 

You want to start saving early for sure – if you can start as soon as your child is born, that’s awesome. Now, instead of simply saving money in a savings account, you can invest the money you save in asset classes like stocks, real estate etc that tend to appreciate over time and also can compound. So in the above example, if you decided to invest money in stocks and wanted to end up with $200K in 18 years and had a full 18 years to invest, you could get away with investing $600 a month. I made some other assumptions here on growth rates but it’s important to note that similar to retirement, you want to start de-risking the portfolio in terms of the asset allocation as you get closer to the college age. So you would start moving more money to lower risk assets like bonds or even savings accounts where the returns get much lower, as your child nears college going age. 

So all this sounds a bit complicated. Do I need to figure all this out by myself? Fortunately not. Below are some common savings vehicles you could use in the US that will help do all this for you. Now, I know that in countries like India, some of these savings vehicles don’t exist. But the fundamental concepts can be adopted. I am briefly going to touch on some of these. But I would encourage folks in the US to check out https://www.savingforcollege.com/ for a comprehensive overview of all the options and this site is considered the gold standard when it comes to resources for college savings. 

1. 529 College savings funds – In the US, we have these college savings funds that come with some good tax advantages. I am personally a big fan of the 529 accounts and I have accounts opened for both of my kids. You will contribute after-tax money into these but the growth is tax free and if the money is withdrawn for qualified college expenses, the withdrawals are also tax free. But if you don’t use it for college, then you will need to pay a penalty and taxes. There is tremendous flexibility in my opinion with these accounts because you can transfer these to another child or relative, they can be retained by your child for higher education or ultimately simply withdrawn by paying the penalty. You can read more about these here: https://www.savingforcollege.com/intro-to-529s/what-is-a-529-plan 
2. Other Education savings accounts – I won’t go into too much detail on these but there are 2 other education specific type accounts in the US called the Coverdell Savings Account and prepaid tuition plans. Prepaid tuition plans basically are exactly what they are called – you literally prepay tuition in a specific college in today’s dollars for education at a later date. They can be transferred to other universities but they are available only for residents of specific states and they are limited in number today. Prepaid tuition accounts are simply another version of 529 accounts with some restrictions. Coverdell savings accounts behave the same as 529 accounts but they limit the annual contributions to $2000 per child and there are income limitations to contribute to them. So overall, these types of accounts tend to be less popular. 
3. Roth IRA – Some people dislike the lack of flexibility on the college focused funds. What if my child does not go to college? What if I want the ability to use the money for other purposes? Well then, you can simply contribute to a Roth IRA. Remember, contributions can be withdrawn anytime without any penalties but you cannot withdraw the growth in the accounts. 
4. Real Estate – this is a non-typical way to save. But I have heard of some families buy a rental property per child and say this property will pay for my child’s college. So what they intend to do is buy a property at the time the child is born, have it paid off fully over the 18 years and at the end of the 18 years, they have an appreciated asset and when they sell it, they can use it to pay for college. There is more to real estate investing obviously and this is not as passive as the other options. You can read more about real estate investing from my articles on real estate here.  
5. Custodial accounts – these are accounts you can open for minors that are not tied to any specific purpose. They are also called UTMA and UGMA accounts. These can be any type of accounts like a savings account, a brokerage account and so on. Like in a 529, you can invest money through the brokerage account. But they dont come with the tax advantages of 529 accounts. They also have a bigger impact on financial aid which I will explain later. So overall, these are not the best suited accounts for saving for college but some people like it due to the flexibility of using the funds for any purpose. 
6. Regular taxable brokerage accounts – ultimately you can simply open a regular taxable brokerage account and save money. It’s the ultimate in terms of flexibility but does not enjoy any of the favorable tax treatment. If you choose to do this, the only word of advice I would offer is to open a separate one for the express intent of saving for college so you simply have it bucketed for that purpose and will be less inclined to touch it for something else. If you are outside the US in a country like India, this is probably still the best way to invest for your child’s college. 

Ultimately whichever savings tools/products you choose to use, there are 3 fundamental pieces of advice I would offer:

1. Keep it as a separate bucket – I know I said this already but I cannot say it enough. This is easier when you invest in college focused funds but if you are doing it through any of the other approaches, please keep it separate.That way you will be less inclined to touch it for any purpose other than college. 
2. Keep a separate account for each child – There is a practical and a more philosophical reason for doing this from my perspective. Originally I decided to save only in one 529 account but I quickly realized there were challenges with doing so because each child had a different time horizon and so different savings needs. That was the practical reason. Philosophically, I just want each of my kids to have their own buckets of money rather than co-mingle them and potentially have any conflicts later on. 
3. Automate this – This is so simple yet so powerful. You should simply allocate a certain amount every month to go from your checking or savings account to your child’s college fund. Then you dont have to think about it and it just happens. I talked about automating your finances in general in more depth in this article.

What about financial aid and scholarships?

There is a whole host of information out there on this and that is beyond the scope of this article. Two things I want to highlight. 

• One, irrespective of what happens, you should encourage your children to apply for all forms of financial aid and scholarships. While I am not the expert on this, I have read and listened to a number of folks who have said going all out and applying for aid and scholarships has really made a dent in the overall cost. And you don’t have to be a 4.0 GPA type student to get this – you will be amazed at all the options out there. But it requires a lot of hustle. 
• Two, one of the concerns people have is if I save too much, my kid won’t be eligible for financial aid. So in the US, this applies only to need based financial aid (not merit based financial aid or scholarships) but even then, it has only a very small impact. I won’t go into the minutia of the EFC (Expected Family Contribution) calculations for the need based aid but needless to say this should not be a reason for you to not save. For eg. if you invest in a 529, your EFC only increases by 5.64% of the value of the 529. A bigger impact of the EFC calculation is your actual income at that time. 

Concluding thoughts and comments

Saving for college is an important and sizable financial goal similar to saving for retirement or for a house. So if this is something you want to do, it is important to plan for this ahead of time. And its never too late – so please dont feel disheartened if you have a child who is 10 or 12 years old and you are just starting to think about this. 

I hope this article gave you some basic information and guidance on how to think about saving for college. Thank you for reading and I wish you success in your financial journey.

Disclaimer: I am not a financial advisor and all the information in my articles are from my personal experience and are for informational and educational purposes only. Please consult with a financial advisor or CPA for professional advice.