If you experienced sticker shock the first time you bought diapers for your baby, you're in for a rude awakening when you start pricing a college education. With the cost of tuition, room and board, fees, and textbooks outpacing inflation by leaps and bounds on a regular basis, the time to face this beast is now. With a realistic plan and time on your side, you can make the move from diapers to dorm rooms without a last minute scramble for funds.
How Much Does College Cost?
The latest Trends in College Pricing report published by CollegeBoard.org reveals the following average annual costs (tuition, fees, and room and board):
• Four year public colleges and universities (in-state) – $17,131
• Four year public colleges and universities (out-of-state) – $29,657
• Four year private colleges and universities - $38,589
These figures do not include other expenses such as textbooks, supplies, and transportation, so assume an additional $4,000 per year for those expenses. Based on these estimates, the average student entering college in 2011 and graduating four years later can expect to pay anywhere from $84,524 to $170,356 for a four year degree.
How Much Will College Cost in the Future?
Do those numbers take your breath away or make $72 a month for disposable diapers look like a bargain? If higher education costs continue to rise at the pace they've been rising (an average of 5.6 percent above general inflation each year for the past decade according to College Board's report), the cost of college for your baby could be astronomical.
For example, let's take that four year public college (in-state) figure of $17,131 and assume a 6 percent tuition inflation rate. How much would the average four year in-state public college cost 17 years from now? The first year would cost over $46,000 not counting textbooks and supplies. Assuming prices stay the same for all four years, your baby's college education would cost over $184,000 (plus textbooks and other expenses).
Have your sights on a private university? Using the same criteria, the first year would cost nearly $104,000. Four full years would cost over $415,000 plus textbooks and other expenses.
Why Saving Now Makes Sense
If you're like most new parents, you don't have hundreds of thousands of dollars hanging around. In fact, you're likely scrimping just to keep the baby diapered and fed. While these numbers are massive, many believe that higher education is the next economic "bubble" that will inevitably burst. As with the real estate bubble burst, obtaining student loans could become more difficult to obtain. Either way, do you want your baby to take on hundreds of thousands of dollars of debt 17 years from now? Probably not.
Fortunately, time is on your side. Depending on how old your baby is, you could have up to 17 years to prepare. Even investing a small amount regularly in a college savings plan could make a significant difference thanks to the power of compound interest. With compound interest, the interest that your money earns is applied toward the balance. Your larger balance earns even more interest which is then added back into the account once again. The cycle repeats, allowing your balance to grow quickly.
In addition, most college plans include tax advantages. For example, if you invest in a 529 plan and use that money for approved college expenses, the earnings will not be subject to federal taxes, and in most cases, state taxes. Not only can your money grow quickly thanks to compound interest, the earnings can grow tax free.
Types of College Savings Plans
Many options exist for saving for college including setting up a Coverdell education savings account, a Uniform Gifts to Minors Act (“UGMA”) account, a 529 plan, and more. Below are two of the more popular ways to save for college:
• Funding a Coverdell Education Savings Account (ESA) – Once referred to as "Education IRAs," Coverdell ESAs are trusts created specifically for paying for the beneficiary's qualified education expenses. Coverdell ESAs are subject to numerous limits including annual contribution limits and parental income limits. Though contributions are not tax deductible, earnings accumulate tax-free. If not used to pay for qualified educational expenses by the time the beneficiary reaches age 30, earnings will be taxed as regular income and a 10 percent penalty will apply.
• Funding a 529 Plan – 529 plans come in two flavors: prepaid tuition plans and college savings plans. Both get the 529 name from section 529 of the Internal Revenue Code.
With a prepaid tuition 529 plan, you buy shares for future tuition at today's tuition rates at your in-state public college. For example, if you buy a year's worth of shares of tuition today, 17 years from now, those shares will be good for a year's worth of tuition regardless of how much costs have risen.
With a 529 college savings plan, you can set aside money for virtually any college your child may eventually attend. The money is invested in a managed portfolio which is subject to market fluctuations. Like Coverdell ESAs, 529 plans have limits and penalties. Funds in a 529 plan can be assigned to a different beneficiary if the original beneficiary does not need them. For example, if your first child gets a full scholarship, you can name your second child as the plan's beneficiary without incurring any penalties.
Tips for Funding Your Baby's College Savings Account
You understand the importance of saving for college now and may even have opened a college savings account, but where are you going to get the money to fund it – especially with a lot of your discretionary money going toward diapers?
Get creative. If you have a $5 off coupon for diapers, use it and put $5 in your baby's college fund. When your baby's potty trained, take the $75-$100 you were spending each month on diapers and put it in the college fund. Suggest contributions to the fund in lieu of gifts. Sign up for automatic withdrawals from your paycheck or bank account to your baby's college fund. As your income grows, increase your monthly contribution. Before you know it, your small efforts will yield rewards.
As you cradle your little one in your arms, remember that your baby's future is in your hands. Start saving for college now.