Will College cost $72K or $386K? It Depends on when you Pay for it!

Wondering how much it will cost to send your children to college someday? The answer depends on a number of factors, including the school your child chooses, the financial aid package awarded, scholarships, and inflation rates on tuition between now and then. 

These factors are typically beyond your control. But one factor you can control – and that may have the greatest impact on the net cost of your child’s college tuition – is when you pay for college. 

Most of us understand that college will cost us more if we borrow the money to pay for it rather than save for it. However, few truly understand the full implication of this difference. When you save and invest for college, you leverage compound interest (assuming positive returns over the investment period) to help do some of the work. When you borrow to pay for college tuition, interest is still being used, however, it's the bank that's using it to their benefit and at your expense. 

Let’s look at a very simple example to illustrate this point. Let's assume your child is a newborn and will someday attend the University of Massachusetts (UMass) Amherst. For the 2021/2022 school year, UMass Amherst costs about $30,000 annually for in­-state tuition, including room and board. Assuming an annual 4 percent growth rate in tuition, UMass Amherst should cost approximately $61,000 per year by the time your child gets there in 18 years. The total cost for all four years will end up being about $244,000. 

So how much will it actually cost you to pay for this $244,000? If you are fortunate enough to be able to fully fund a college savings account on the day your child is born (happy birthday!), it would cost you $72,200 to fully fund the account. This figure assumes that you achieved an average annual 7 percent growth rate over the entire investment period and ignores income taxes on the growth. The $72,200 number is so low compared to the actual cost of tuition because you are leveraging your savings with compound interest to lower your overall cost of college. 

Now let’s look at this from the other side of the equation. What if instead of saving, you borrowed to fund the cost of college? How much would that cost you in total? 

To keep it simple, let’s assume that the interest was subsidized while your child was attending college and so it does not accrue during their active enrollment. In this case, assuming a 20­ year loan with a 5 percent interest rate, four years of college will end up costing you (or your child) $386,500.  In this example, saving for college, rather than borrowing means you paid one fifth the cost. 

Clearly, this is an extreme example because few would have the resources to save 100 percent in advance. However, the point is that no matter how much you can save now, the long-­term impact of that savings could be dramatic in reducing the total cost of college. 

Once you’ve resolved to save more for college, there are a variety of financial vehicles that can help. One of the most popular of these vehicles today is the 529 College Savings Plan. This state­ sponsored plan allows you to grow your college savings on a tax­ deferred basis. As long as the distributions are used to fund higher educational expenses, then distributions from the account should be tax­-free. However, if you needed to use the money for purposes other than higher educational expenses, then the gains on those distributions would generally be subject to income taxes and a 10 percent penalty on top of that. 

By planning property, using compound interest to your advantage rather than to your disadvantage, you could achieve the significant financial goal of paying for your children's college educations at a far lower cost to you and your family. 

Breakwater Financial, LLC is a registered investment advisor. The content of this blog post is for informational and educational purposes only and is not to be considered investment, legal or tax advice. If you have any questions regarding this blog post, please contact us.

Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital.