Mark Kantrowitz’s College Savings Cheat Sheet

college savings piggy bank

I spoke with college finance expert Mark Kantrowitz about saving for college.

Katie Couric: What are your thoughts on the recent trend of colleges reducing their tuitions? Why might it not be quite what it seems?
Mark Kantrowitz: When a college cuts its tuition rates, it is a one-time event designed to generate publicity which, in turn, leads to enrollment increases. In most cases, financial aid will also be cut. So the net price will remain unchanged or go up slightly. So, it does not really save the student any money.

After the year of the tuition reset (which sometimes is spread over two years), the college returns to a regular cycle of inflationary increases in tuition rates.

Students who don’t qualify for financial aid may benefit the most from a tuition reset.

Generally, the colleges that pursue a tuition cut are tuition dependent (they don’t have big endowments), small (less than 5,000 undergraduate students), less selective (SAT scores typically in the range of 1100 to 1300) and are not well known nationally.

There are about 273 colleges that match the criteria for a tuition reset. Not all of them will do so, but the phenomenon should continue for a decade or two.

Our article on tuition resets can be found here.

Katie: What’s the biggest misstep that you see people make as they attempt to plan for paying for their kids’ education?
Mark: Procrastination is a common mistake. It is cheaper to save than to borrow. Every dollar you save is a dollar less you’ll have to borrow. Every dollar you borrow will cost about two dollars by the time you repay the debt. But, only 18 percent of children under age 18 have 529 college savings plans.

Another common mistake is failing to consider college affordability. Often, the student gets their heart set on a single dream college. The parents then say, “if you get in, we’ll pay for it.” But, the parents don’t realize that college is much more expensive today than when they went to college. When the child gets into an expensive college, the parents don’t know how to say no, forcing them to borrow too much money to pay for the college.

Parents have a tendency to overestimate eligibility for merit aid and underestimate eligibility for need-based aid. They also aren’t aware that most colleges meet financial need with loans, not just grants.

To ensure that a college is affordable, compare total resources (savings, contributions from income and education tax benefits like the American Opportunity Tax credit, and reasonable debt) with the net price of a four-year education. When calculating the four-year net price, don’t just multiply the first year’s net price by four. About half of colleges practice front-loading of grants, where the net price is lower the first year than in subsequent years due to a better mix of grants vs. loans. Use to compare average grants and the percentage receiving grants during the first year with the figures for all undergraduate students, add the difference to the first year net price and then multiply by four.

(I often recommend that students pick three dream colleges. According to the American Freshman Survey conducted by UCLA’s Higher Education Research Institute, 94% of American freshmen are enrolled at one of their top three choices. The pick-three approach increases the likelihood of getting into a dream college and being able to afford to enroll.)

This leads to another common mistake, which is over-borrowing. If total student loan debt at graduation is less than the annual starting salary, the student should be able to repay their student loans in ten years or less. Otherwise, they will struggle to repay their loans on a 10-year repayment term. Instead, they will need an alternate repayment plan, such as extended repayment or income-driven repayment. These repayment plans reduce the monthly payment by increasing the term of the loan. Not only does this mean you’ll be repaying your student loans for 20, 25 or even 30 years, but you’ll also be paying much more interest.

A similar rule of thumb applies to parents — don’t borrow more for all your children than your annual income. This includes cosigned loans — a cosigner is a co-borrower, equally obligated to repay the debt. This assumes that retirement is 10 or more years away. If retirement is less than 10 years away, reduce the student loan debt accordingly, since the goal is to retire with no debt. For example, if the parents plan on retiring in just five years, they should borrow half as much.

See here for a discussion of how to have the college money talk with your children.

Katie: How should parents balance the competing needs to save for their own retirement and their children’s education…what’s your advice?
Mark: Many pundits refer to the flight safety demonstration to argue that you should put your own gas mask on first. But, when was the last time you asked a flight attendant for personal finance advice? The advice to save only for retirement works only if you assume that someone else is paying for college.

If you save for both college and retirement, you will end up with more money for retirement than if you borrow for college and save for retirement. The cost of repaying the parent loans will reduce the amount you can save for retirement. It is cheaper to save than to borrow.

Thus, the optimal strategy is as follows:

  • First build an emergency fund with about half a year’s salary. This rainy day fund will help you cover unanticipated expenses, such as the need to replace your house’s HVAC system or roof, or an unemployment spell. 
  • Next, maximize the match. If your employer matches contributions to your 401(k) or other retirement plan, contribute enough money to maximize the match, as that’s free money.
  • Next, aim to save about a third of future college costs, which is the same as the full cost of a college education the year the child was born. This is the more immediate goal, so it is more time critical. 
    • Start saving for college as soon as the child is born. Your greatest asset is time. If you start saving from birth, about a third of the college savings goal will come from the earnings. If you wait until the child enters high school, less than 10% will come from earnings and you’ll have to save six times as much per month to reach the same goal. (It’s never too late to start saving, because every dollar you save is a dollar less you’ll have to borrow.)
    • If you start saving from birth for a child born this year, you’ll need to save $250/month for an in-state public 4-year college, $450/month for an out-of-state public 4-year college and $550/month for a private 4-year college. 
  • Lastly, live below your means, so you have the means to live. You should save one fifth of your salary for the last fifth of your life. Unfortunately, most people save a lot less, typically around 7%. 

Katie: Middle income families can sometimes feel that they get the short end of the stick because they’re too wealthy to qualify for financial aid, but still can’t afford the cost, but a new report by Sallie Mae actually found that not to be the case. What’s your take?
Mark: This sort of grass-is-always-greener argument makes assumptions that aren’t true. Parents should stick to mowing their own lawn.

The unfortunate reality is that everybody struggles to pay for college. Even after subtracting the grants, scholarships and other gift aid, low-income students pay a greater share of total family income to enroll at a community college than middle-income students pay to enroll at a private non-profit 4-year college.

The ratio of net price to total income is the college affordability index, a concept I created more than a decade ago. If the college affordability index for one year of college costs is less than 25%, the college is affordable. (For four years of college costs, the college affordability index should be less than 100%.)

Government support of postsecondary education has failed to keep pace with increases in college costs on a per-student, inflation-adjusted basis. This has shifted the burden of paying for college from the federal and state governments to families. But, family income has been flat since the late 1990s. This forces families to either shift enrollment to lower-cost colleges, such as from private colleges to public and from 4-year to 2-year, or to borrow more. The bottom line is the government is not paying its fair share of college costs. Federal and state government benefit from a college-educated populace, since college graduates pay more than double the income taxes of people with just a high-school education. Increasing the number of college-capable low-income students who earn Bachelor’s degrees will pay for itself in about a decade. But, most people have a 40-year or longer work-life, so that leaves 30 years of pure profit. It could even lead to a reduction in tax rates. The annualized return on investment to the federal government, for example, is the equivalent of a 14% return on investment. It’s not just a good investment; there is no better long-term investment.

Katie: What would you say to parents who are worried that they haven’t saved enough? What’s the most important thing they can do to get on track?
Mark: It’s never too late to start saving for college. Every dollar you save is a dollar less you’ll have to borrow. So, by saving money, you will literally save money. If you live in a state with a state tax break on contributions to the state’s 529 plan, you can even start saving after your child enrolls in college, treating the tax savings as a discount on tuition.

Sticker shock often leads to savings paralysis. So, don’t focus on the sticker price. Instead, just get started saving for college. Once you get started, it becomes easier to find ways to increase the amount you save each month.

If you want to benchmark how much you should have saved so far, multiply the child’s age by $3,000 for an in-state public college, $5,000 for an out-of-state public college and $7,000 for a private college. Then, make up any shortfall with a lump sum contribution or by spreading out the shortfall over the remaining time before the child enrolls in college.

Katie: This is so helpful. Thanks, Mark!