The Smart Way to Pay for College

Posted on June 18, 2013
Filed Under Mutual Funds, Personal Investing, Retirement savings

When it comes to paying for your kids’ college, procrastination can be a costly mistake.

Just how costly? According to a new study by mutual fund firm T. Rowe Price, borrowing to pay for tuition, rather than saving and investing ahead of time, can effectively double the cost of your child’s education.

As you may know, so-called “529 plans” are ideal for parents (or grandparents) who want to put money aside for a child’s college education. Your investment grows tax-deferred, and distributions to pay for the beneficiary’s college costs come out federally tax-free.

The T. Rowe Price study found that a family borrowing $25,000 today, at a 6.8% interest rate, would end up repaying about $35,000 over 10 years, or $288 a month.

On the other hand, parents would be able to provide that same $25,000 tuition by putting $92 a month into a 529 college savings plan for 15 years. Assuming their 529 plan returns 6% per year and charges annual fees of .85%, the parents would need to invest just $17,000.

So it’s either paying $17,000 up front or $35,000 later on. That sure seems to be a no-brainer decision.

The bottom line: Saving to pay for college, rather than using loans, can cut your costs by more than half. No one wants to send their children out into the world under a crushing debt burden. Making smart choices ahead of time is a way to avoid that scenario. 

T. Rowe’s study carries its hypothetical example further, illustrating the ripple effect of making smart financial decisions. Rather than repaying $35,000 to a bank, the parents of the college student could stuff that money into a Roth IRA. Assuming an average annual 7% rate of return, that amount would grow to $100,000 in 20 years.

If you have young children, it can be tempting to procrastinate rather than save for their college education.  But don’t. Experience has shown that families who take action now to meet future goals tend to be more successful and prosperous in the long run.

And by the way – a certain baby-food company is now hawking a “college savings” plan that’s also a life insurance policy. Don’t fall for that. For college, open a low-cost 529 plan, and for insurance, buy low-cost term life insurance.

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