Hello fellow BoaS readers! I’m ProfessorFI over at theFIprofessor.com. I’m a professor at a major research university (not of personal finance, I’m afraid) and working toward FI. I’m new to the FI community and BoaS resonates with me, as my partner and I balance our careers, two young kids, and attempt to strike a balance between the cold hard logical decisions and following our passions in life.
Bottom line: If you can afford quality daycare, you can afford college.
When Kid 1 was on the way we were ecstatic. We dreamed of family trips, watching him grow up, learn to drive, cultivate a hobby and passion in life, go to college, and – wait – who is paying for this? The next step is to reflect on what you know – your own experience, that of your family and friends, or whatever Google tells you. You see numbers like $20,000 per year (tuition, fees, room and board) and think “ok, that might be manageable”. Then you remember that doesn’t include inflation and rapidly growing college costs. A calculator tells you it is as simple as stowing away perhaps $750/mo in a tax-saving 529 plan and you start thinking it is plausible. Then, of course, you remember the daycare bill is also looming.
Today’s topic is how to pay for college, including a simple calculator you can use. This is written from my own situation, meaning I’m anticipating: (1) paying for childcare outside of the home; and (2) a desire to fund college expenses for your child. The calculator I’ve put together allows you to adjust lots of assumptions about costs, rates, etc. but the framework should be useful as a starting point.
Of Daycares and Degrees: Two major but predictable costs of raising a child
Cost 1: Daycare
Starting perhaps 6 weeks after your child is born – assuming both parents are back to work after mom’s FMLA expires – the first expense hits. Of course, you anticipated this because quality childcare is hard to find and you’re on any number of waiting lists. My daycare provider knew that Kid 2 was on the way before I did!
For us, daycare for a 3+ year old costs about $850 per child per month and has been increasing on par with inflation. But, I do remember when we looked at the rate tables watching the fees fall as children grow older, particularly from newborn to 3 years old. For reference, here are approximate costs at a local daycare that we used when we first moved to town:
Newborn to 1 = $1070/mo
1-2 = $1025/mo
2 <3 = $950/mo
3+ = $850/mo
(As quick aside – Mr. BoaS tells me “seriously?! that’s cheap!”. But in my town this is on the more expensive end of daycare options, so your mileage will vary. Use the spreadsheet to customize for your own expenses)
For simplification I build the calculator using a single value, but savvy readers will readily see how they can adjust these costs to change as your child grows.
Already you can see that with each passing year you are saving money! If you can swing that $1070/mo in year 1, by the time your kids turn 3 you’ve got $2,640 of “extra” money around each year ($220/mo x 12 mo = $2,640). Plus, when your child starts kindergarten you’re the proud new owner of an additional $10,200 in annual income that you are no longer paying to for childcare.
As a side note – this seems too good to be true, right? Right. Childcare isn’t exactly a non-expense after daycare is over, but is it massively diminished. We currently spend about $150/mo for after-school care for Kid 1. Still, that is tiny compared to full-time costs for daycare.
Cost 2: College
So you want to fund college for your child? Awesome! If they choose to take advantage of your generosity and attend college, plenty of studies show that is one of the best returns on investment for their personal financial stability (and future FI if they follow in your footsteps).
Now, what is this really going to cost? The good folks at CollegeBoard.org publish an annual report on Trends in College Pricing. Their average prices for 4-yr college tuition and fees in 2017 are:
$9,970 for in-state public
$25,620 for out-of-state public
$34,740 for private
In addition, annual room and board expenses are estimated at $10,800 for public and $12,000 for private. I’ll just use $11,000 for planning purposes.
The same group indicates that college costs have been outpacing inflation by 3.2% over the last decade, so we’ll use that to forecast expenses (along with an assumed inflation rate of 2%, so costs are increasing at a rate of 5.2% annually in this study). Thus, when your 2017 newborn starts college in 2036, you can expect total annual costs more like:
$54,941 for in-state public
$95,944 for out-of-state public
$119,838 for private
Woah. Let’s just let that sink in for a minute. In about 18 years you’re in need of that money, and lest we forget that is just one year of a 4-yr degree program (plus inflation and cost increases while your little one is in college, of course).
Proposed Strategy: Never stop paying for daycare
If you’re a current parent with childcare or you’re expecting, you’ve heard it. “I can’t wait for junior to get to college – this daycare payment is killing me!” My partner and I heard this and thought that really wasn’t such a bad idea. After 6 years of daycare we have a lifestyle that is set-up for spending at least $850/mo (2017 dollars) on daycare for each child. So, why change that?
As a quick comparison, you’ll note that at $850/mo (or $10,200/yr), we’re already covering more than the average tuition and fees at an in-state public school. Maybe this isn’t actually that bad?
Enter the calculator. A simple spreadsheet to test the offhanded “daycare is costing me more than college” remark. Without getting into the nitty-gritty calculations – which you can see for yourself in the spreadsheet – let me review the basis for this calculation (aka my life):
- $850/mo daycare cost
- 2% inflation
- 3.2% cost growth for college above inflation
- 4% growth rate on 529 investments
- $20,970/yr costs in 2017 dollars to cover in-state public tuition, fees, room and board
Results: Baseline scenario
For the baseline, assume that you continue to put 100% of your daycare funds into a 529 plan. This means you’ve saved nothing until kindergarten begins and you increase by 2% per year to keep up with inflation. Calculator says…
…success. Boom. Mic drop. See that sweet balance of about $52,967? That means you ended up with way more money than you needed! You have managed to over-save. Also, for you new or expecting parents out there, if you can afford daycare you can afford college! Wahoo!!!
Results: Optimizing to save exactly enough
Okay – over-saved by more than $50,000?! Let’s try and get closer to correct. The calculator is set up so you can use goal seek to quickly adjust to suit your fancy. For example, I used goal-seek to set my final balance to $0 by changing the fraction of daycare payments I would save each month. For me, the result was about 83.2%, meaning if I save 83.2% of what I would have spent on daycare, I can fully fund college at an in-state public school). See the revised plot below:
Nice, right? I have no delusion that all the assumptions are correct, but I do know that if I’m saving about 80% of my daycare costs I’ll have a substantial chunk of this expense in the bank when I need it.
Results: Early Saver
What if you’re an early saver? If you can put $100/mo into that 529 starting at birth, you’ll only need to save about 69% of your daycare expenses each month, and you’ll reduce your total contributions by about $4,510. Make that $250/mo and you’re looking at less than 50% of your daycare payment and saving more than $10,000 in required contributions. The power of compounding. And these numbers only get better the stronger your return on investment goes (again, we just assumed 4% for all calculations above – you can adjust the risk tolerance of your portfolio in most plans).
Do we really do this?
Not quite. We are currently saving more like 40% of Kid 1’s daycare costs each month now that he is in kindergarten, and also $150/mo for Kid 2 who is still in daycare. When Kid 2 finishes daycare we’ll up both to about 60% of daycare costs. That won’t cover everything, but it will cover more than half of our anticipated expenses for each. By the time Kid 1 and Kid 2 get to this college we plan to have no debt (freeing up our monthly mortgage payment to help cover college expenses as they come) and a nice cushion of liquid assets to cover any outstanding costs.
Reflections and Cautions
Yes, there are a lot of built-in assumptions here. Probably wrong, but ultimately useful (as is the case for most forecasts). Constant rates for everything is clearly wrong, particularly if you adjust your portfolio blend as your child nears college (just as you may do with your retirement savings as you age). I already pointed out daycare costs are not really fixed, especially in the early years.
Your child’s birth date relative to the school calendar is probably one of the largest sources of uncertainty. For example, kindergarten typically starts for children who turn 5 by a particular date, usually early August. Thus, if you have a baby born in September you’ll perhaps have 11 “bonus” months of daycare payments to contend with. This also starts to matter if you’re making contributions in addition to daycare savings (included in the calculator as an option).
Based on the assumptions I’ve made, if you can afford childcare on a monthly basis, you should be able to save more than enough for college. I’ll note here that your particular situation could vary widely (higher childcare costs in some cities, different risk tolerance for return rates, etc.), but I hope this is a useful place to start.
Okay, now let me have it
I’ve been describing this all as being in a 529 plan. I’m picking that because a 529 plan is a generically useful way to save for college expenses, and in some states you can get a decent tax break (which we don’t account for in the calculations). That said, if you save too much or don’t need it, there are restrictions on withdrawals. Is a 529 best? Should 100% of your savings go into one? Do you have better strategies?
So…if you’ve stuck with me this long, I could use some help. What is missing from this? What considerations should I add to the document or calculator? How are you saving for college?
PS Mr. BoaS here. You need to check out the spreadsheet ProfessorFI used to make those charts. I have it here.
It will also be part of the other spreadsheets only my email subscribers have access to ;).