Pete the Planner's guide to college planning

Saving for college has become increasingly difficult for American families. There are two primary reasons for this: 1) decreasing financial sensibility 2) college price inflation. While this blog is always dedicated to helping you overcome financial sensibility deficiency, today's post is dedicated to helping you deal with skyrocketing college price inflation. Cool?

I very much enjoy the "college is too expensive" conversation. I'm dedicating two hours of my radio show to this very topic this coming Friday. I'll post the podcast of the show here early next week. College education has become increasingly inefficient. Whereas technology is leveraged in many industries to decrease consumer costs, colleges (for the most part) have refused to pass on the saving to consumers. Not only that, but colleges have been able to take advantage of student loan subsidization and push college costs even higher. Check out this chart from FinAid.org. If shows college inflation compared to general inflation. College inflation is almost double general inflation. That's not cool.

YearCollege InflationGeneral InflationRate Ratio1958-19967.24%4.49%1.611977-19869.85%6.72%1.471987-19966.68%3.67%1.821958-20016.98%4.30%1.621979-20017.37%3.96%1.861992-20014.77%2.37%2.011985-20016.39%3.18%2.011958-20056.89%4.15%1.661989-20055.94%2.99%1.99

What does this mean? It means since the US Government is guaranteeing student loans, that more students can borrow. Which in turn means that demand for a college education is high. And competition to attract and retain students is even higher. This leads to some pretty nutty stuff. Why does your college have a climbing wall? Why does your alma mater have dorms nicer than most three star hotels? All of these amenities cost money. And you are paying for it. Well, your student loans are paying for it.

Am I against sending your child to college? Absolutely not. However, I am against cost inefficiency. I encourage you to seek out institutions that honor their commitment to their students' financial futures. For instance, Grace College has a four year degree that you can earn in just three years. This reduces student tuition costs by 25%. That makes sense to me. You?

So what should you do? It's pretty simple: plan. I guess if I was Bob the Builder I would tell you to build. But since I'm Pete the Planner, the answer is to plan. The easiest way to fund college is to fund this goal over time. If you start saving right away, then time becomes your friend. If you wait until your kid is old enough to spell college, then time is your enemy. Here's what I mean:

$200 saved per month for 18 years (started the month your child is born) at a hypothetical 8% rate of return will give you $97,071.03 by the time college rolls around.

$200 saved per month for 12 years (started on your child's 6th birthday) at a hypothetical 8% rate of return will give you $49,188.71 by the time college rolls around.

Waiting just 6 years cuts your college savings IN HALF!!! That's not good, but it's math. So don't fight math. Use math.

Where should you put your money?

There are several ways to save for college, but choosing the right one can mean the difference between needing student loans and avoiding student loans. Your method for savings should allow you to defer taxes. This means that you don't have to pay taxes on your investment growth. Your Roth IRA works the same way. It grows tax deferred. The most popular college savings vehicle is the 529 plan. This plan allows you to invest your money into a tax deferred education fund. The money can then be used for college expenses. But here is what makes them VERY attractive in my opinion: many states will give you a tax credit for investing in one. That basically means that you will get a tax refund for a portion of your deposit. For instance, in Indiana by depositing money into the College Choice plan, you are eligible for a 20% tax credit on your deposits up to $5,000. This means that if you deposit $5,000, then you will receive a $1000 tax credit. That means that you will possibly get a $1000 check from the state (some restrictions apply). Therefore, a $5,000 deposit can become a $6,000 deposit, if you deposit the $1,000 tax credit back into the plan.

Let's see how that would affect our original calculations:

$240 saved per month (original $200 plus 20% from tax credit) for 18 years (started the month your child is born) at a hypothetical 8% rate of return will give you $116,485.24 by the time college rolls around.

$240 saved per month (original $200 plus 20% from tax credit) for 12 years (started on your child's 6th birthday) at a hypothetical 8% rate of return will give you $59,026.45 by the time college rolls around.

That's a huge increase! And all you had to do was save into the right college savings vehicle. Be sure to check on the rules in the state in which you live. Here's a list of the different state tax rules (provided by FinAid.org).

State529 DeductionAlabama$5,000 per parent ($10,000 joint)AlaskaNo state income taxArizona$750 single or head of household/$1,500 joint (any state plan)Arkansas$5,000 per parent ($10,000 joint)California--ColoradoFull amount of contributionConnecticut$5,000 per parent ($10,000 joint), 5 year carryforward on excess contributionsDelaware--FloridaNo state income taxGeorgia$2,000 per beneficiaryHawaii--Idaho$4,000 single/$8,000 jointIllinois$10,000 single/$20,000 joint per beneficiary (25% tax credit for employers for matching contributions up to $500 per employee)Indiana20% tax credit on contributions up to $5,000 ($1,000 maximum credit)Iowa$2,811 single/$5,622 joint per accountKansas$3,000 single/$6,000 joint per beneficiary (any state plan), above the line exclusion from incomeKentucky--Louisiana$2,400 single/$4,800 joint per beneficiary, above the line exclusion from income, unlimited carryforward of unused deduction into subsequent yearsMaine$250 per beneficiary starting 2007 (any state plan), above the line exclusion from income, phaseout at $100,000 single/$200,000 jointMaryland$2,500 per account per beneficiary, 10 year carryforwardMassachusetts--Michigan$5,000 single/$10,000 joint, above the line exclusion from incomeMinnesota--Mississippi$10,000 single/$20,000 joint, above the line exclusion from incomeMissouri$8,000 single/$16,000 joint, above the line exclusion from incomeMontana$3,000 single/$6,000 joint, above the line exclusion from incomeNebraska$5,000 per tax return ($2,500 if filing separate), above the line exclusion from incomeNevadaNo state income taxNew Hampshire--New Jersey--New MexicoFull amount of contribution, above the line exclusion from incomeNew York$5,000 single/$10,000 joint, above the line exclusion from incomeNorth Carolina$2,500 single/$5,000 joint, above the line exclusion from incomeNorth Dakota$5,000 single/$10,000 jointOhio$2,000 per beneficiary per contributor or married couple, above the line exclusion from income, unlimited carryforward of excess contributionsOklahoma$10,000 single/$20,000 joint per beneficiary, above the line exclusion from income, five-year carryforward of excess contributionsOregon$2,090 single/$4,180 joint (i.e., $2,090 per contributor) per year, above the line exclusion from income, four-year carryforward of excess contributionsPennsylvania$13,000 per contributor per beneficiary (any state plan)Rhode Island$500 single/$1,000 joint, above the line exclusion from income, unlimited carryforward of excess contributionsSouth CarolinaFull amount of contribution, above the line exclusion from incomeSouth DakotaNo state income taxTennessee--TexasNo state income taxUtah5% tax credit on contributions of up to $1,740 single/$3,480 joint per beneficiary (credit of $87 single/$174 joint)Vermont10% tax credit on up to $2,500 in contributions per beneficiary (up to $250 tax credit per taxpayer per beneficiary)Virginia$4,000 per account per year (no limit age 70 and older), above the line exclusion from income, unlimited carryforward of excess contributionsWashington, DC$4,000 single/$8,000 joint, above the line exclusion from incomeWashingtonNo state income taxWest VirginiaFull amount of contribution up to extent of income, above the line exclusion from income, five-year carryforward of excess contributionsWisconsin$3,000 per dependent beneficiary, self or grandchild, above the line exclusion from incomeWyomingNo state income tax

Some parents don't want to pay for the cost of college. I don't have a problem with that at all. You can always finance a college education, but you can't finance retirement. I would just encourage you to make a decision rather than having your lack of action make your decision. I honestly think that college costs will become more efficient. I think there will be a giant student loan default crisis in the next 5 years, and this will help reset college costs. People will think twice about borrowing tons of money that they have no means of paying back. This will bring down demand, thus bringing down colleges prices. It will be exactly like what happened to the housing market in the last 4 years.

Remember, start early. It will make it much easier on you. BONUS TIP: As your child progresses through different stages of life, take advantage of expenses left behind. What does this mean? This means that when you stop spending money on diapers, increase your college contributions by the exact amount you spent on diapers. When you stop paying for daycare, make deposits into your college plan for the amount you spent on daycare. This is the absolute best way to supercharge your colleges savings plan. Good luck!! And don't forget to listen to my podcast on this topic next week. I will post it for you.

*****Check with your investment advisor on the investment risks involved with college savings plan. Many of them are variable in nature, which means risk.******