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Savings Goals

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Before you begin to invest, you need to define your savings goals. Decide how much you need to save by the time the child will reach college age. You could choose a specific dollar amount, such as the projected cost of public college tuition by the time your child is ready for college. Or you could choose to devote a fixed percentage of your income to your children's future college costs. Whatever you do, you should have a clearly defined goal, so that you can plan how to reach that goal and measure your progress toward that goal. Having a goal will help motivate you to save.

Remember, a college education is in investment in the future of your children. It is the best investment you can make. For example, the US Census Bureau reported in December 2000 that the average income for students with a bachelor's degree is $45,678 almost twice the $24,572 income of a student with just a high school diploma. That's a difference of almost $1 million in lifetime earnings, as reported by the Census Bureau's July 2002 report, The Big Payoff: Educational Attainment and Synthetic Estimates of Work-Life Earnings. The US Census Bureau also conducts annual surveys of educational attainment, with the results published every March. The income by educational attainment tables (table 8) are based on data that is one year old. For example, the 2006 survey, published in March 2007, uses 2005 income data. The following table illustrates some findings that can be derived from the 2006 survey data.

Degree Annual Income
Age 18+
All Workers
Lifetime Income
Age 25-64
Full-Time Year-Round Workers
High School Graduate $26,933 $1,531,400
Associate's Degree $36,645 $1,920,680
Bachelor's Degree $52,671 $2,742,160
Master's Degree $66,754 $3,337,800
Doctoral Degree $91,370 $4,449,440
Professional Degree $112,902 $5,612,760

This shows that a bachelor's degree recipient has lifetime earnings of more than $1.2 million more than someone with just a high school diploma, and a doctoral degree recipient more than $1.7 million more than someone with just a bachelor's degree.

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When to Start Saving

You should save as much as you can, even if it is only $25 or $50 a month, and you should start saving as soon as you can. Put the power of time to work for you.

The sooner you start saving, the more time there'll be for compound interest to build up a nice college fund for your children. A family that starts saving $10 a week at birth at 4% interest will accumulate $12,663.44 by the time the child turns 17 and enrolls in college. If the family waits until 4 years before college to start saving, they'll have to save $56.12 a week in order to reach the same goal. If the family waits until the year before college to start saving, they'll have to save $238.60 a week to reach the same goal. Note that the family that starts saving at birth gets 30% of their saving goal from interest compounding, while the families that starts saving when the child enters high school gets a little less than 8% of their savings goal from interest. Time is your most precious asset; don't squander it.

The best time to start saving is at birth. But if you haven't started saving yet, the best time to start is right now. It is never too late to start saving.

The trigger events that most often cause families to start saving for their children's college education include:

  • Birth of a child.
  • Child entering kindergarten (e.g., around age 5) or first grade (e.g., around age 6).
  • Child entering high school (e.g., around age 12 or 13).
  • A review of the family's finances.
  • A review of investment, tax and estate planning strategies.

How Much to Save

When parents first start trying to decide how much to save, they often get overwhelmed by the cost of a college education. Four years of college for their children will cost four to seven times as much as their own education cost their parents. Even in constant dollars that's two to four times as much. For a child born today, their college education will probably cost three to four times as much as it costs today.

Statements like "a baby born in 1998 will likely have four-year college expenses totalling $300,000 by the time he or she matriculates in college" may have great shock value, but they are not realistic. There two key points to remember about such statements:

  • They are based on the costs of the highest priced institutions. According to the College Board, in 2006-2007 the average tuition of a four year private college was $22,218 and a four year public college was $5,836. (Total annual costs were $33,301 and $16,357, respectively.) But only 7% of students attend colleges where tuition costs more than $30,000 a year. Approximately 42% of students attend colleges where tuition and fees cost less than $6,000 and 71% attend colleges where tuition and fees cost less than $12,000.
  • These are gross prices, not net prices. On average, the net cost after subtracting grants is 25% lower. The higher the cost of the institution, the more aid you're likely to get.

One-Third Rule

In addition, you don't need to save the full amount. A good rule of thumb is the one-third rule. This rule states that you should expect to save one third of the expected college costs, pay one third from current income and financial aid during the college years, and borrow one third using a combination of parent and student loans. Effectively, one third will be coming from past income (savings), one third from current income, and one third from future income (loans), letting you spread the cost of a college education over an extended period of time.

(If you did want to save the full $300,000, you'd have to save $107.64 a week or $466.04 per month from birth in order to reach their goal at 5% interest. That's about as expensive as an additional car payment or child care expenses. Most families cannot afford to save this much.)

Given that long-term tuition inflation is 8%, children born today will pay at least three times current college costs by the time they matriculate. Combining this with the one-third rule, it follows that parents of a newborn should use current college prices as a goal for their college savings. In other words, set the savings goal based on college costs in the year the child was born.

Other Rules of Thumb

Besides the one-third rule, a few other good rules of thumb for deciding how much to save are as follows:

  • Try to save at least 10% of your paycheck (per child), starting the day the child is born. (If you wait until the child enters first grade, you will need to save 18% of your salary per child.) This figure assumes a median household income. FinAid has a savings plan calculator you can use to determine what percentage of your income to save.
  • Try to save 10% to 15% of each year's college costs (per child), starting the day your child is born.
  • Try to save at least $2,500 per child per year from birth. That's about $50 a week or about $210 a month.
  • If your state offers a tax deduction for contributions to section 529 plans, maximize your tax deduction.
  • Base your savings goal on paying full freight at a public college in your state. This should be a little less than half the cost of the most expensive private college, offering you a more reasonable goal. This is a good proxy for what your net costs after financial aid will be at a more expensive college.

Additional tips on making it easy to save can be found on the College Savings Tips page.

Savings Growth

Try to avoid being overwhelmed by the numbers. Save whatever you can, even if it is just $25 to $50 a month. The difficult part is getting started. Once you start saving, you will find it easier to increase the amount you save later.

The more you can save, the better off you'll be. Saving just $25 a week from birth to age 17 at 5% interest will yield $34,839.45, a nice college fund.

The following table shows the results of saving different amounts per week at different interest rates and various numbers of years to enrollment. The first three columns correspond to a family that begins saving when the child enters high school. The last three columns correspond to a family that begins saving when their baby is born.

Growth of Weekly Savings
Weekly
Amount
0%
4 years
5%
4 years
10%
4 years
0%
17 years
5%
17 years
10%
17 years
$10 $2,080$2,304$2,559 $8,840$13,936$23,263
$25 $5,200$5,759$6,399 $22,100$34,839$58,157
$50 $10,400$11,518$12,797 $44,200$69,679$116,314
$100 $20,800$23,036$25,594 $88,400$139,358$232,627

The following table shows how much you'd need to save per week in order to reach various savings goals at 8% interest at different numbers of years to enrollment.

Weekly Savings Required to Reach Savings Goal
Goal 1 year4 years8 years12 years17 years
$5,000 $92.29$20.38$8.58$4.77$2.66
$10,000 $184.58$40.76$17.16$9.54$5.32
$25,000 $461.45$101.92$42.88$23.86$13.28
$50,000 $922.90$203.84$85.76$47.72$26.56
$100,000 $1,845.82$407.68$171.53$95.42$53.11
$250,000 $4,614.54$1,019.20$428.81$238.56$132.78

If you'd like to see the results of different savings plans, FinAid includes several interactive calculators to help you.

 

 
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