Coping with College Expenses

The following is a guest post from Marotta Asset Management. (Editor's note: The author is from Virginia, hence the reference at the end.)

An old axiom states that nothing is certain except death and taxes. But now we have to add the skyrocketing costs of a college education.

According to the most recent College Board Annual Survey of Colleges, the sticker price of a college education keeps rising, faster than the price of groceries, health care and almost everything else in the basket of goods used to determine the Consumer Price Index (CPI). In the last 10 years, in-state tuition and fees at public four-year colleges increased 5.6% annually on top of a CPI growth of 2%. The average estimated total expenses for a current public in-state four-year student are an astounding $81,356.

If you were blessed with the birth of a child recently, you will need to save $430 monthly to pay for in-state college tuition, fees, room and board. Double this rate to cover the full costs at the average private institution. And this doesn't even include money for a cell phone, pizza, room decor or other stuff that college students deem "necessities."

Most students don't pay full price for college. In 2009-10, undergraduate students received an average of $12,894 in financial aid, split almost equally between loans and grants. Grants are the most attractive because students are not saddled with a repayment plan after college. Federal grants make up 26% of total aid. Institutional college grants account for 17%, state grants for 6% and private and employer grants (scholarships) for 4%.

Students are graduating with larger debt loads than they were 10 years ago. Public four-year college borrowers graduate with an average of $19,800 in debt. Their nonprofit private college counterparts graduate owing $26,100. This private college debt is 17% more than it was 10 years earlier, even after accounting for inflation. In addition, a growing percentage of all college debt is unsubsidized and begins accruing interest immediately.

Our experience suggests not all college degrees are created equal. In May, the New York Times profiled a recent graduate of New York University who majored in women's and religious studies. With more than $100,000 in debt, she is struggling to repay her loans, meet her living expenses and regretting her selection of an expensive private school.

Students will have to make more astute education choices. Today's global marketplace places more value on hard skills such as engineering, computer technology, teaching and finance. Technical degrees and certificate programs will become commonplace. A liberal arts education will likely diminish in popularity and become more focused at the elite institutions. More students are likely to begin their education at lower cost community colleges and complete a four-year degree at schools that specialize in their concentration.

Parents may feel overwhelmed about the amount they need to save for college. But college education is one of the two lifetime investments for which we approve borrowing money (the other is a home mortgage). Students should plan to graduate with a debt load no higher than half of what they can reasonably expect from their first year's salary. For example, those with a starting salary of $40,000 should keep their debt at or below $20,000. Thus graduates can dedicate 10% of their annual salary to school debt and pay it off in five years.

New parents should immediately begin saving $430 a month for college. Alternatively, a onetime $50,000 investment should cover tuition, fees, room and board at an in-state college 18 years from now.

Giving a child the gift of a college education and a debt-free start to adulthood is one choice. Other parents believe their children should participate in financing their college education and can apply the 50/50 savings approach. Parents commit to saving half of the money needed, and their children commit to the other half. Students participate by working hard in high school, applying for scholarships, taking summer jobs, seeking out work study opportunities and accepting reasonable loan levels.

The support of grandparents can help tremendously. The vast majority of the college accounts that we manage are owned and funded by grandparents. Instead of buying the latest gadgets for their grandchildren, they make annual contributions to a college savings account. If the grandparents own the account, it has the added advantage of not being included as a resource on the student's financial aid forms.

The 529 plans are still the most cost-efficient way to save for college expenses. If the grandparents are Virginia residents, they are entitled to a $4,000 state tax deduction, which saves them $230 each year per account. Or they could each open one account for their grandchild and double the savings. This money grows tax deferred and is tax free when withdrawn, akin to a Roth IRA. The 529 plans have the additional benefit of an upfront state tax deduction.

Comments

[Roy]

We had two Daughters two years a part in age and were a one income family. We had some saved for their college and told them if they kept up their grades in school we would pay for their college at a public school. When our youngest left home for college my wife decided to join the work force and we paid for tuition, books, room and board as we went. Our Daughters worked part time for living expenses like car, car insurance, and food and clothing. When they graduated they had no debt, we didn't have to touch our savings and now had extra income besides. My wife continued to work until we had grand children and we decided my wife would quit her job and do the day care for our grand children. We are blessed that our children could have careers in our area.
I think this shows the flexibility you have by living on one income and someone being home to raise the children. I know this is harder to do now for young couples including our children.

[David R.]

Thank you for the hard numbers. As a UVA alum ('07) myself, I'm all too familiar with the rising costs of college. I graduated with about $22,000 in student loan debt, and after 3 1/2 years, I've reduced that number to roughly $5,900. I'm on track to pay it off completely by mid- to late 2011.

I'm of two minds when it comes to parents paying for all of a child's tuition. On the one hand, it allows the young graduate to enter the world with a blank slate. This lets the new graduate pursue volunteer positions or low-paying opportunities of interest without the ball and chain of student loans.

On the other hand, I could see how some students would blow off their responsibilities if their tuition was covered. After all, they're not paying for college, so they have nothing invested in their performance there. I would hope this is a minority of students, but I saw a fair number of people with silver spoons and no work ethic.

Perhaps a combined approach is best: The parents shoulder the majority of the tuition and fees, while placing some of the responsibility for living expenses on the student.

[Matt]

There are alot of factors in the equation for college. Is Jack and Jill a honor student or average? Are they athletic or nerdy? All lead to opprotunities for scholarship money or grants. Our son is looking at $3000 sholarship money just for attending a competition that will also grant $6000 or $12000 a year depending on how you do in the competition. A friend of ours son is looking at swimming scholarship worth $20k a year. Money is out there if you are looking for it.

$430 a month is if you want to Jack and Jill a full free ride without any help. I say shared responsibilities. I am not paying ALOT of money for a kid to go to school to screw around and get bad grades, which I feel my son will not do, however there are no free rides in this world.

I worked during college to pay for alot of expenses. Actually 80% of my college. Others was loans.He will have to figure out the same.

I saved money in a 529 and have about the first year covered. I have the next year saved in a mutual fund. I am working on saving for the third year.

Another factor is degree. What if Jack and Jill want to be a stunt car driver? or an actor? Well that is what our son was thinking but eventually he found a field of study that he wants to go into.

So that 50k one lump or $430 a month would look nice with that master degree in stunt car driving or acting.

[Don Current]

Excellent article with a lot of good data, not just opinions.

I'm assuming that the average grant/loan combination listed for '09-'10 includes students of both public and private institutions? That would be awesome if that was for public institutions only. There are people out there who help students find scholarships and grants. This can be a good investment if they have a proven track record. Make sure and do your research though to avoid getting scammed. One student that Dave Ramsey talked about spent his summer looking for scholarships and grants instead of making minimum wage at McDonald's for the summer. He got $75k that summer. I'd say that was a pretty good investment of his time.

That comment about starting to save $430 a month toward college ought to scare anyone into thinking harder about college planning! I would say for a large percentage of parents, that would be a struggle.

Our state (Indiana) also provides a benefit to those investing in a state 529 plan. You currently get a 20% tax credit for a 529 investment of up to $5000 per year. That means if you put in $5000, they give you $1000 back when you file your taxes. I like a 20% immediate return on my money! I'm hoping that continues until I can get my kids off to college!

[Jonathan]

These numbers aren't accurate - $430 per month for 18 years (216 months) is $92,880 without a penny of interest. At a reasonable 5% interest, this amount will generate $150,000 in 18 years, and by the end of the 4 years of college, that amount would cover $40,000 a year if you stopped paying in at age 18.

Bump up the return on investment to 10%, and you only need to save $135.47 per month for 216 months to have $81,356 by age 18, or put in a $13,550 lump sum at birth. These numbers are far more reasonable, and within the realm of possibility for most families.

[Jim]

Good article. Probably one of Marotta's best. I appreciate that there aren't randomly made up figures and gross bias randomly inserted like usual.

[Money Reasons]

In Ohio, our state 529 plan only has a $2,000 state tax deduction, but it's still better than nothing!

Within my kid's 529 plan, I went with the age based allocation, but I don't think I would go that route again, if I were to start over from scratch...

[Linda]

I think college education costs are the real downfall to people saving for their retirement anymore - if your parents couldn't pay everything, or you get a full scholarship, come out with debt and spend years trying to pay it off. Finally have children, try to see to it that they can avoid that trap and become unable to save for retirement. At least for those of us in the middle.

[Rick]

Jonathan, you ignored inflation in your calculation. Using the trend numbers from the College Board website, the $81,356 figure would be about $240,000 in 2028. Therefore, the author's advice to save $430 a month is reasonable given the other assumptions represented in the article.

With all the numbers thrown around in this article, there's a lot of potential for misinterpretation and miscalculation. For example, in the second paragraph, one might be led to believe that the $81,356 figure resulted from a compounded annual growth of 7.6% over the last 10 years. But note the difference between "in-state tuition and fees" and "estimated total expenses." According to the College Board report, total expenses, including room and board, increased at a lower rate than just tuition and fees: 4.2% vs 5.6%.