By the time a child born today is ready to attend college, the total cost of four years at an elite school may be approaching half a million dollars.
That is a serious burden even for families with strong incomes. In fact, those families may find themselves too wealthy to qualify for financial aid, but not so wealthy that the cost of college doesn't strain their household budgets. For people in that situation, advance planning is the key to making it all work out.
Determinants of college financial aid
A good starting point is figuring out just how much money you are going to need for your children's college education. If you hope they will attend an elite school such as Harvard or Stanford, expect the total cost of attendance to be around $70,000 a year today.
Assuming they graduate in four years, that comes to a total of $280,000 -- not factoring in the cost of graduate school. Worse yet, Ivy League schools and Stanford enjoy endowments that enable their costs to be a bit lower than other highly selective schools. If your student is accomplished but not quite so much that he or she merits one of the approximately 1,200 spots in an Ivy League incoming class, the annual full cost of attendance approximates $75,000 at certain other highly selective schools.
For many parents, that cost is offset somewhat by financial aid. Formulas determining financial aid vary, but here are some general guidelines:
- Income is more significant than wealth
College financial aid is often based on the gap between the cost of college and a figure known as the Expected Family Contribution (EFC). The EFC is the amount the student's family is expected to contribute to the cost of college. It takes into account both income and assets -- but of the two, income plays a bigger role in determining the EFC and thus your potential eligibility for financial aid.
- The cost of the school makes a difference
Because aid is often determined by the difference between the cost of the school and the EFC, you may stand a greater chance of qualifying for aid at a more expensive school.
- Parents with more kids in school are eligible for more help
The family's EFC is spread among however many children are attending college at a given time. Therefore, if you have multiple students in college, the EFC for each may be smaller, increasing the chance that they might qualify for aid.
The point is, there is no hard and fast cut-off point at which a family earns too much to be eligible for financial aid. The more expensive your family's college costs are, as a function of how many children you have attending college and the cost of the schools they go to, the more likely you are to be eligible for aid.
You can apply for financial aid via the FAFSA website for federal aid and for non-federal aid by completing the College Board's College Scholarship Service Profile, an application process used by nearly 400 colleges and scholarship programs.
College savings projections
Suppose your attempts at getting financial aid come up empty. Just how big a burden is sending a child to an elite school likely to be?
As noted previously, the total cost of attendance can be in the neighborhood of $70,000 per year today. However, if you are planning for the future, keep in mind that this number is likely to grow with inflation.
According to figures from the College Board, college costs have grown at an average rate of 2.5 percent a year over the past three decades. If you've just had a baby and want to plan ahead for the child's college costs, a 2.5 percent annual inflation rate would mean that the total annual cost for an elite school could be around $109,260 by the time that child reaches college age.
In that scenario, you'd need to plan for $437,040 in costs for four years of college. That's enough of a financial hit to put a budget strain even on households with strong incomes. The key becomes saving in advance so you can spread the burden out over a period of several years and benefit from some investment growth over time.
If you started saving as soon as your baby was born, you could accumulate that $437,040 for college costs by saving $15,535 per year assuming a 5 percent after-tax investment return. Even if you don't start right when a child is born, the point is that the earlier you start saving and investing for college, the more manageable the financial burden becomes.
Saving for college: growth and liquidity
Saving money for college is just part of the job. You also need to invest the money wisely to get the most out of it. The two key investment considerations are growth and liquidity.
Growth vehicles like stocks entail taking some risk. This is another reason why it is so important to get an early start on college saving -- it allows you more time to ride out the ups and downs of the stock market. If you invest in stocks on behalf of a newborn baby, there is a good chance your investments will have earned a gain by the time that child is ready for college. However, as the time to tap into the money draws nearer it becomes prudent to shift to more stable investments.
This is where liquidity comes in. Make sure that the financial resources you need for college are available when the bills arrive. This means that, as the time to start paying for college draws near, you should favor investments that are fairly stable and are either readily marketable or produce a regular stream of income.
529 college savings plans and other options
529 college savings plans are popular vehicles because they offer the advantage of tax-free investment gains, as long as withdrawals from the 529 plan are used for approved college costs. Within a 529 plan, you should be able to choose growth-oriented investment options when college is still many years away and then shift toward more conservative investments later on.
The tax advantage of 529 plans is greatest for long-term investments. Once you get nearer to starting to pay for college, you may find other investments can also help. Here are some examples:
- A CD ladder
This could be structured so that your CDs are scheduled to mature just before the college bills come due. Setting up a CD ladder a few years in advance may allow you to feature longer term CDs and thus earn higher interest rates.
- Income-yielding bonds
These can also be structured to produce regular amounts of income to coincide with the college's billing cycle. Just make sure you use very high-quality bonds with little or no default risk.
- Income-producing real estate
This could allow you to make a long-term investment in real estate but still produce some measure of liquidity for college expenses. The key is to make sure the mortgage is scheduled to be paid off before the child starts college, or else you may see much of your rental income offset by mortgage payments. It also helps to make sure you have established a reliably high occupancy rate so you can be reasonably confident that the income will keep coming.
Paying for college without financial aid is a huge job. If you start planning far enough in advance, there's a great chance that someday you will be proud to say it was a job well done.