The average cost of public in-state college tuition, fees, room and board in 2020-21 is $26,820 a year and $54,880 for a four-year private college, according to a recent study by the College Board. For a child born today, the four-year cost of college is expected to be $526,629 for private and $230,069 for public, according to a recent study by J.P. Morgan. Imagine if you have two or three kids?
True, there is financial aid, merit and athletic scholarships. Most schools discount the sticker price. But there is no guarantee your child will receive aid, so we must plan. Sadly, I find most parents lack a plan for college savings. Parents have good intentions and care for their kids, but for one reason or another they never get around to setting anything up. Parents who say they do “have a plan” often are merely throwing some money aimlessly into an age-based 529 college savings program. That is a good start, but not enough to meet the six-figure future cost of college. Planning for the astronomical cost of college requires more. It requires a thoughtful, meticulous plan.
For my clients, we start with reviewing their goals and objectives. We review the expected cost of public and private college in their home state. Then parents may decide to try to cover 100% of college costs, 50% or maybe a third. Having a goal in mind is extremely important. It creates motivation and lessens anxiety. We then review their monthly cashflow to find a number they feel comfortable allocating into a college savings program. From there we devise a holistic plan. We review their employer plans, such as deferred compensation or company stock plans, insurance needs and expenses, discuss retirement savings, inheritances and anything else that’s important to the conversation. We then review several college saving recommendations.
Here is one: Forget age-based options.
How parents fail to make the most of 529 plans
You probably are familiar with the 529 college savings plan. These programs are a solid choice for college savers. Contributions are after-tax (no federal tax-deduction up-front), earnings grow tax-deferred, and withdrawals for qualified higher-education expenses (room, board, tuition and some fees) are income tax-free. In addition, assets in a 529 plan receive preferential financial aid treatment when owned by a parent. A maximum of 5.64% of parental assets count toward a family’s Expected Family Contribution (EFC) when applying for federal financial aid, versus 20% of a student’s assets (Source: Savingforcollege.com). There are penalties for not using 529 money for college, namely a 10% penalty on withdrawals, plus the earnings are income taxable.
Many parents are familiar with 529s, but many don’t fully utilize the program. In practice, I find parents contributing monthly to a 529 into an age-based mutual fund. On the surface this seems logical. An age-based mutual fund invests in more aggressive equity mutual funds for younger children, then automatically shifts to more conservative bonds as the child ages and gets closer to college. This makes sense, as you want 529 money to be conservative as the child gets closer to withdrawing the money for college. Age-based funds are set-it-and-forget choices, meaning busy parents don’t have to manage the investments themselves.
Personally, I don’t care for age-based options.
Age-based mutual funds are for the most part too conservative. For example, Vanguard’s 529 age-based mutual funds own some bonds for all ages, starting at age zero! This means a newborn, 18 years away from needing the money for college, has some conservative, low-yielding bonds in the account. Fidelity’s Connecticut Higher Education Trust (CHET) 529 age-based option for a child 18 years away from college — the 2039 portfolio — has 5% in bonds. The 2036 portfolio — for a child 15 years from college — has 14% in bonds.
This is a huge mistake, in my opinion. Bonds are too conservative for a child that young. I understand the importance of asset allocation, having been in the business for 20 years. I use bonds to diversify portfolios and believe bonds play an important role in helping a portfolio weather a stock market storm, as bonds usually hold up better in a stock market crash. But I also understand that a newborn child has a long, long time before needing the money for college. In 18 years, the child’s account will see many stock market corrections, booms and busts. I am not so concerned…