For years, college costs have been rising at a rate that well outpaces inflation, and a growing number of students are getting priced out as a result. It's therefore encouraging to learn that this trend might be slowing down, at least as far as four-year public colleges are concerned.
The College Board reports that sticker prices at public colleges this year did increase, but at a lower rate than in years past. And while it's too soon to tell whether that limited growth will translate into lower net costs in the near future, there is a chance that prices might finally start to come down.
Still, when it comes to affording college, the overall picture is bleak, with tuition bills increasingly monopolizing families' income. The average cost for a year of public college now equals 20% of the median U.S. household income, compared to just 14% back in 1993.
Even if college costs do start to decline, unless we see a drastic drop, a large number of families will continue to struggle to keep up. Fortunately, there are ways that families intent on paying for college can get closer to meeting that goal.
The problem with paying for college is that by the time many families get serious about saving for it, they're left with a relatively small window. Setting money aside when children are young, therefore, can help families do better.
Imagine you start putting away $300 a month for college when your child turns 8. Assuming that child will begin his or her studies at age 18, that's a 10-year window you have to build savings. If you invest your savings at an average annual 7% return (which is more than doable with a stock-focused strategy), you'll be sitting on $50,000. That's certainly a respectable amount, but seeing as how the average cost of a four-year public college today is more than $21,000 a year when we factor in tuition, room and board, and mandatory fees, that's not necessarily enough to fund a four-year, in-state degree.
On the other hand, if you start setting aside that same $300 a month when your child turns 3, all other things being equal, you'll have $90,000 to work with. And that could, in theory, cover a four-year in-state degree in its entirety, based on current rates.
In addition to prioritizing college savings early on, the type of account you save in could impact the amount of money you wind up with. That 7% return we just talked about? You won't get it if you keep your college fund in a regular savings account. Rather, as mentioned above, you'll need to invest your money to achieve that sort of growth.
When it comes to investing, you have several options. You could open a traditional brokerage account and save there. The benefit is that your funds won't be restricted in any way. If your child gets scholarships or doesn't end up going to college, you can withdraw that money and use it for another purpose without penalty. The downside, however, is that you'll be liable for taxes on gains in your investment account year after year, which means you'll not only lose money to the IRS, but you'll have less available to reinvest annually.
That's why you're generally better off saving for college in a 529 plan or Roth IRA, both of which offer tax-free growth on your money. With the former, you can contribute regardless of what you earn, and you're not subject to annual contribution limits. And depending on where you live, you might score a tax break for funding an account. The downside, however, is that if you overfund your 529, you'll face a 10% penalty on money used for noneducational purposes. That said, that penalty applies to the gains portion of your account only and not to your original contributions.
If you save for college in a Roth IRA, you'll be limited to a $5,500 annual contribution if you're under 50 or $6,500 if you're 50 or older. You also won't be eligible to fund a Roth directly if your earnings exceed a certain threshold (though you can always pay into a traditional IRA and convert it to a Roth after the fact). The plus side, however, is that you don't have to use the money in your Roth for college; you can technically withdraw your principal contributions at any time without penalty, and if your child ends up getting a free ride to school, you can save that money for retirement.
Whether the cost of public college will go down is yet to be determined. But one thing's for sure: It's pretty astronomical at present, so the sooner and more efficiently you begin saving, the better your chances of tackling those bills once your child is ready to pursue a degree.