How Much Should You Save for Your Kids' College?

Dear Carrie,

My two kids aren't even in school yet, but the cost of college already scares me. I don't want them to wind up graduating with a lot of student loans like I did, but I don't see how I'm ever going to come up with the money. How can I save enough?

—A Reader

Dear Reader,

Looking at today's college costs can give a parent sticker shock—let alone projecting the costs when your young kids are college age. But while the numbers can be daunting, the reality is many parents today pay far less than the published prices for both public and private colleges. With the cost of college getting a lot of scrutiny these days, that may be even truer in the future. This doesn't mean you don't need to save, it just means you may need to save less than you think.

Whatever future costs may be, saving early and using a tax-advantaged account like a 529 can be a smart way to prepare. But before we look into some of the details of a 529 college savings plan, let's look at some current stats you may find encouraging.

There can be a big difference between sticker price and what you pay

We kind of take for granted that we'll usually pay less than the sticker price for the car we drive off the lot. Surprisingly, the same holds true for published college costs. According to recent College Board research, while the average annual sticker price for tuition, fees, room and board at a four-year public college for '20-'21 is $22,180, the actual cost to students and families averages about $14,850. For a private four-year college, the costs are $50,770 vs. $29,110. The difference is due to financial aid in the form of scholarships and grants—not counting student loans. So for starters, it’s best not to take published costs at face value.

Paying for college isn't all on the parents

Student debt is a heavy burden for a lot of college grads as you well know, but there are other ways to cover college costs beyond loans and parents' savings and income. How America Pays for College 2020 reports that while parents generally picked up 44 percent of the bill for the 2019-20 academic year, the rest was covered by:

• Scholarships and grants (25 percent)
• Student income and savings (8 percent)
• Relatives (1 percent)
• Parent and student borrowing (21 percent)

The point is you may have options you haven’t considered. So before you throw up your hands in despair, consider how you might share the responsibility for your kids' education costs. Are there grandparents or other family members that might pitch in? Will you expect your kids to contribute? An honest discussion now could open some doors to future possibilities and ease your concerns.

Also, put some real figures in front of you. Use a college saving calculator to explore scenarios and decide on a realistic savings amount. And the U.S. Department of Education has resources and calculators to help you determine current and future sticker and net prices.

Concern about your kids being saddled with student loans is understandable. I'd advise any parent with kids approaching college age to complete the FAFSA (Free Application for Federal Student Aid). Financial aid comes in a lot of forms, and even parents who don't think their kids will qualify, should take time to find out for certain. Currently more than 80 percent of students who apply receive some form of financial aid. To me, that's also encouraging.  

Starting to save early can make a big difference

While there may be many ways to help pay for college, starting to save early is one of the smartest strategies. Which brings me to a 529 savings plan. A 529 is a state-sponsored program that allows parents, family members—anyone—to invest in a child's education. You open the account in your name with the child as beneficiary. Contributions are then made in the name of the child.

Why consider a 529 and not some other type of savings account? Several reasons, including:

• Tax-deferred growth
• Tax-free withdrawals for qualified education expenses 
• Possible state income tax deductibility or credit for 529 contributions
• Low impact on financial aid eligibility
• Low account-opening minimums
• Can be used to pay up to $10,000 tuition per year for K-12 schools, and up to $10,000 in student loan payments

On the other hand, 529 plans include a 10% withdrawal penalty on earnings on top of ordinary income taxes if money is not used for qualified educational expenses.

Most plans make it easy to invest by offering a number of pre-set portfolios you can select based on your child's age and your feelings about risk. A 529 is also flexible. If your child doesn't go to college, the money can be used for certain other types of post-secondary education. Plus you can change the beneficiary from one child to another (or even to yourself). That said, you may want to consider opening a separate 529 for each child.

Set some realistic goals—for your kids and yourself

I think of saving as a series of steppingstones to a more secure future. Best to take it a step at a time. First, set some priorities. As a parent, I understand wanting to put your kids first, but I'd make retirement a top priority. If you have a 401(k), contribute at least enough to get the company match. If you don't have a 401(k), consider opening an IRA.

Then review your budget in light of all your savings goals to determine a monthly college-savings amount. If you can, put it on automatic. It may not be a lot at first, but get started now and add more when possible, maybe with gifts or family contributions. Having something like a 529 will give your education savings a focus—and allow you to check your progress on reaching your goal.

I'd suggest getting your kids involved with planning and saving for their future. Teach them the basic idea of saving once they're old enough to handle money of their own. When they have an allowance or a part-time job, encourage them to contribute something to their own education. Involving them in saving for college can enrich your kids' futures in many ways. A bit of financial education now will be something they'll thank you for, whatever the future brings.

Have a personal finance question? Email us at askcarrie@schwab.com. Carrie cannot respond to questions directly, but your topic may be considered for a future article. For Schwab account questions and general inquiries, contact Schwab.