College,  Planning,  Savings

Is there a college savings rule of thumb?

Let’s talk college savings. Just when you thought you were starting to get a handle on saving for retirement/your post-career phase now, we have to add college savings into the mix. As if you needed another thing to worry about!

Let’s go ahead and ask the hard question.

Are you on track with your college savings?

No clue? You’re not alone. Most people have no idea.

With crazy high inflation and large cost differentials between schools, it can be hard to know if you are in a good place when it comes to your college savings, or if you need to “kick it up a notch.”

With that in mind, Fidelity has introduced a new rule of thumb for college savings. It sounds pretty straightforward: take your child’s age and multiply it by $2,000. If you have at least that much money in your college savings account, you’re on track. If you don’t...well, it’s not too late to catch up!

Let’s do a quick example:

Say you have three kids...hypothetically speaking...a 7 year old future lawyer, a 5 year old future corporate raider and a 2 year old future offensive tackle. Using Fidelity’s new “rule of thumb” you would need to have the following amounts saved for college to be considered “on track.”

For your 7 year old: 7 x 2,000 = $14,000

For your 5 year old: 5 x 2,000 = $10,000

For your 2 year old: 2 x 2,000 = $4,000

That would mean a whopping total of $28,000 in total college savings!

I’ll wait while you breathe into a paper bag.  

Now that the lightheadedness is starting to fade, let’s evaluate the tool and its merits. This new “rule of thumb” sounds pretty simple right? Of course, as it is with most things in finance, it’s not as simple as it seems. While the rule is somewhat helpful it may not apply to your personal situation and goals.

Is this a College Savings ‘Rule of Thumb’ you can rely on?

Maybe. Let’s go through some of Fidelity’s assumptions and see if they apply to you.

The rule of thumb assumes 50% of college is paid for with savings, 20% is paid for with loans or scholarships and 30% is paid for out of current income.

I fully expect people will have to pay for college at least partially out of current income. Frankly, I’m planning on doing that. However, I do think it’s a little disingenuous to tell people they are “on track” with their college savings and then tell them their savings would only cover half of the cost of college. Now, for some families, there is an expectation that the student will contribute, perhaps significantly, to the cost of college. That’s fine.

Key Take Away: Parents should bear in mind that this rule of thumb only covers half the cost of college.

The rule of thumb assumes 20% of the cost of college will be paid for with loans or scholarships

Let’s face it, this means primarily loans for higher income earners, which may not be appealing to some of those families. If you don’t want your child to have to borrow money for college, or if you don’t want to borrow money on their behalf, then you will need to save more than this rule of thumb suggests. Alternatively, you could plan to pay for more of school out of pocket.

The rule assumes a high rate of college inflation - 5.5% to be exact.

This is a reasonable assumption as according to the 10 year college inflation rate is about 5%.

Fidelity assumes that your investments will only earn a slightly higher rate of return than college tuition inflation rates.

I think this is an appropriate estimate. If you’re having trouble sleeping you can check out Vanguard’s estimates for future stock and bond performance.

Even with these caveats you only have 75% odds of success.

Alright, this means that 25% of the time, or 1 out of 4, the college savings was not enough to cover EVEN 50% of college costs. I think those odds of success are a little low. I would prefer higher odds of success, but then you wouldn’t be able to use $2,000 as a handy round number in your “rule of thumb.”

Should You “Plan” to Borrow for College?

For some people it’s not an “if” question but a “how much” question. However, using student loans will make your college expenses even higher, especially if you defer the interest on your unsubsidized loans while you are still in school. Did you know that the interest on some student loans starts accruing while your student is still in school? On many loans it does.

As Navient points out on it’s website, “Generally, interest begins to accrue on Direct Unsubsidized, FFELP Unsubsidized, Direct and FFELP PLUS Loans, and Private Loans as soon as the loan is disbursed.” “Disbursed” means given or made available to the borrower.

In a recent  New York Times article  I was quoted saying many of my clients will be paying full freight when their kids go to college. Let me expand on that a bit. This is not because they won’t have loans available to them, but because loans are not free money. So if you receive a loan for college, you may still be paying the sticker price, but now you have to pay the interest on the loan too. In my state there are a lot of high quality public schools, which tend to offer less financial aid compared to private schools. Also, as it is noted in this CNN Money article, as family incomes approach $200,000 there is less and less aid available to those higher income families.

When someone says you can pay for college with “aid” and then offers you a loan, just know that this is NOT free money. “Aid” sounds generous and simple. Angelic, really. Student loans are not simple, and they can be overly “generous”, saddling families with incredible debt because they don’t fully understand how much money that loan will cost after their student graduates. (Spoiler Alert: If they graduate.)

Should you rely on the 2k College Savings Rule?

If you have read any of my previous posts, you know what I’m about to say. It depends. Is the rule generally reasonable? Sure. Am I relying on it for my family? Not really. My goal is cover closer to 70% of college out of savings - so I know I have some work to do.

Honestly, a part of me thinks they came up with this rule because it won’t scare parents out of their minds. With that being said, if you are reaching for the red wine and realizing that the bottle is now empty, try not to panic. (I should say, try not to panic about college, it’s OK to despair about the wine.) Again, the key here is to get started now and increase the amount you save over time.

So what do you think? Are you on track? What questions do you have about college? Reach out to me on Facebook or in the comments section. Your question could become my next blog post!

Need help saving more money? Sign-up for my free video coaching to help whip your college savings rate into shape - as painlessly as possible! 

Are you trying to have a sticky conversation with your kid about what student loan debt really means? I wrote “Talking to your teen about student loan debt” for you.

Feeling overwhelmed about saving for your post-career phase AND college?  Should You Save for Retirement or College was written for you.

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