How do you know if you are saving enough for college? New Fidelity tools take some of the mystery out of the process and could help ensure that families don’t come up short.
Young parents are saving more than any previous generation. As they struggle through the gigantic student loans they had to take on for their own educations, they are adamant about sparing their own children from the same fate. According to a 2016 Fidelity Investments survey, 72 percent of households are saving for college, compared with just 58 percent in 2007.
But despite good intentions, many are falling far short. While the average parent wants to cover 78 percent of a child’s college costs, their savings aren’t going to do it. Millennials, who are in their 20s and early 30s, are on track to cover 32 percent, according to a Fidelity study. Generation X – roughly those in their late 30s, 40s and early 50s – will hit 28 percent. Baby boomers in their 50s and 60s, some of whom still have children who have not yet entered college, are on track to cover 31 percent.
Part of the problem is that the cost of college is growing so sharply. By the time this year’s newborns get to college, the cost of four years at a public university is likely to be about $200,000. The other problem is that parents simply don’t know what they should be saving. Financial firms haven’t put as much effort into tips for college savers as they have for retirement savers. And no wonder. Retirement saving is a huge business, with about $14.8 trillion invested in individual retirement plans, 401(k)s and other workplace accounts. College saving, done primarily through what are known as 529 college savings plans, totaled just $275.1 billion in 2016, according to the College Savings Plan Network. Only about 2.5 percent of families have one of these college savings accounts.
While there are rules of thumb for saving for retirement, there are few to help parents make their way toward the college years. So I welcomed an effort Fidelity Investments made this week to provide a college saving rule of thumb that anyone could handle. The Fidelity guidance is this: Multiply your child’s age by $2,000 to figure out what savings you should have stashed away for college at each point in your child’s life. So if your child is 2, multiply $2,000 by 2, and you should have $4,000 in the college saving account. If your child is 7, and you want to make sure you’re on track, you should see $14,000 in the account.
Keep in mind that this rule assumes your child will attend an in-state public university, and that you will keep saving and are investing in 529 college savings plans that grow your money between 3.8 percent and 5.3 percent annually over many years, using stock and bond investments. You should realize that the growth is not guaranteed. Stocks can lose at times, but the combination of stocks and bonds historically has grown money more than savings accounts. And 529 “age-based” plans move your money out of stocks when your child gets close to college age.
Most importantly, also realize that the rule only assumes you will be covering 50 percent of your child’s college costs with your savings. If you want to cover more than 50 percent of the costs, you will have to save more. But only a third of families pay full price; the others get some financial aid.
For a quick snapshot of your progress saving, check out this simple Fidelity college savings calculator: www.tinyurl.com/kkt74ye. To see what the full college cost is likely to be when your child hits college age, choose the option on the calculator to cover 100 percent of your savings goal each year of college. When you run the numbers you are likely to see that your current savings are puny compared to what the cost actually will be. But then you can see what saving more will do, or decide to moderate your aggressive intentions.
Realize that you can’t put all your savings into college funds. If you can’t save adequately for both college and retirement, sacrifice college before retirement. As a rule of thumb you should be saving about 10 percent of your pay for retirement, starting in your 20s. Although you may not want your children to borrow for college, they can get student loans. No one’s going to give you a loan at 75 to put food on the table during retirement.
Given the trade-offs on your saving decisions, you may want a college calculator that provides more detail. I like the college savings calculator at the College Board’s site, which operates SAT testing and does a lot of research on college costs and trends. See www.tinyurl.com/mztafv2. This calculator will explain what your costs are likely to be by the time your child goes to college, how you are doing in accumulating enough savings, and what you should be saving if you want to cover a certain amount of college costs.
There will be a couple of questions that may confuse you with this calculator. You will be asked what inflation rate to assume for college costs. The cost of going to college has been rising at 5 percent a year for many years. In recent years, it’s been just 3.5 percent. So I’d choose one of those numbers.
You will also be asked your annual interest rate on your college savings investments. This number is a guess. Based on history, some analysts say to assume 6 percent for a young child because the blend of stocks and bonds in 529 plans has generally provided such a return. But stocks are never guaranteed. If you think the stock market will be slower in the next few years – as some analysts are estimating – you could lower your interest-rate guess to 5, 4, or 3 percent and test the impact on your savings with the calculator.
Just keep this in mind: A common mistake of millennials is to be overly cautious with investments. If you put your money in a savings account it will be safe, but your savings will barely grow over the years. Try putting into the calculator an interest rate of 1 percent for a savings account and see what happens. Your goal of keeping your child away from college loans is likely to explode.
Let’s say you have a 1-year-old, and you save $100 a month until college. If you earn 5 percent on your savings each year, you will be about $71,400 short of what you will need to pay 100 percent of college. If you stick it in a savings account and earn 1 percent, your shortfall will be $80,000.
Before panicking, however, realize that two-thirds of families get financial aid to help pay for college. Don’t just bet on it. Figure out how much you are likely to get with this expected family contribution calculator: www.tinyurl.com/jh24amh.