Calculating How Much You’ll Need To Save For College

Fidelity Investments today released its 4th annual College Savings Indicator study, in which it calculates the percentage of future college costs that parents are prepared to meet. In addition, Fidelity offered guidelines on the amounts that families need to save for college as a % of household income.

Despite the fact that two-thirds of parents are saving for their children’s college education, Fidelity concluded that parents are only prepared to cover 16% of the cost of a college education.

To give parents guidance as to how much they should be saving for college, Fidelity also did a series of calculations in which it estimated the future cost of college, the average amount of financial aid and gifts that a child might expect to receive, and the amounts that parents would need to save to cover their share of the cost of a four-year college education.  The estimates are based on average costs of public and private educations and are segmented by family income level; Fidelity also made some undisclosed assumptions about the investment returns that would be obtained.

Fidelity’s conclusion?  A family making \$55K/year needs to save 3.5% of its monthly income to save for a public college education and 9% for private college (\$160/month and \$410/month, respectively) starting at the child’s birth and continuing through the first three years of college.  At a family income of \$75K, savings for public/private college education of 3% (\$190/month) and 6.5% (\$410/month) are needed, and at \$100K income, 3% (\$250/month) and 5.5% (\$460/month) are required to cover qualified college costs (i.e. not including expenses like transportation and health care).

In response to a New York Times blog post, Fidelity also provided its estimates for a \$150K household’s college savings needs, which worked out to 2% of income (\$250/month) for a public college and 4% (500/month) for a private one.

Although these numbers seem to be in the right ballpark generally, it’s a good idea to take these kinds of estimates with a grain of salt.  As a provider of 529 plans, Fidelity Investments has a vested interest in encouraging families to put money into its 529 plan funds.  These vary in quality; I’ve found that some of these plans have allocations dispersed across some of Fidelity’s least attractive mutual funds.  I also couldn’t find anything in the reports to indicate that Fidelity’s estimates took into consideration the existence of Federal tax benefits related to higher education expenses.

It’s wise to keep in mind that putting too much money into a 529 can leave you at a tax disadvantage. If you need to take money out of a 529 for a non-educational purpose (to cover an emergency expense or just because your child’s education didn’t require as much money as you saved), you’ll owe a tax penalty.  For more information on 529 plans, see this post.  The figures reported by Fidelity are for one child; if you have two children in college at one time, their need-based financial aid eligibility may increase.

Despite the shortcomings of their analysis, these numbers from Fidelity should at least help alert parents to the likely future cost of college.  For most middle-class households, the twin goals of retirement and college educations for children compete with each other for funds, and families need to start planning ahead in order to make sure that one goal doesn’t suffer as they pursue the other.