There are several popular rules of thumb about how much to save for college and how to check whether your college savings are on track to reach your goals.
For example, you may have heard that you should contribute $250 a month from birth to a college savings plan to save one third of future college costs at an in-state public 4-year college.
But, these rules are not static and must be updated periodically. The contribution amounts are rounded to the nearest $50 to yield some stability. Even so, they need to be updated every decade or so as college costs continue to increase.
For example, if a child is born this year, their parents should save $300 a month from birth if the child will enroll in an in-state public 4-year college when they graduate from high school.
Setting a College Savings Goal
The one-third rule sets a college savings goal based on one-third of projected future college costs. It assumes a rough cut approach, where the money for college will be spread out over time. One third of future college costs will come from past income (college savings), one third from current income and financial aid, and one third from future income (student loans).
College costs go up by about a factor of three over any 17-year period. This rule of thumb was based on an assumption of a long-term college cost inflation rate of about 6%. More recently, however, college costs have increased by about 3% per year. Nevertheless, this rule of thumb still works out well in practice.
Combining these two rules suggests that the college savings goal should be the full cost of a 4-year college education the year the child was born, since three times a third is one.
How Much to Save from Birth
Calculating the monthly contribution also depends on assumptions concerning the average return on investment.
The long-term return on investment from investing in the S&P 500 is about 10%. However, the stock market experiences at least three corrections (a drop of at least 10%) and at least one bull market (a drop of at least 20%) in any 17-year period. One can balance the risk of investment loss with investment return by adopting a dynamic investment glide path, such as an aged-based or enrollment-date asset allocation. This yields an average annual return on investment from birth of between 4% and 6%.
The resulting monthly contribution amounts are then rounded to the nearest multiple of $50 to yield some stability, so that the monthly contribution amounts do not need to be adjusted every year.
Comparing the total savings from the high and low contribution amounts with the current 4-year costs suggests the minimum monthly contribution amount needed to accumulate enough money to cover the goal.
Running this analysis on the current one-year college costs for tuition, fees, room and board for 2022-2023 and the current long-term college cost inflation rate yields overall college savings goals. These amounts, in turn, yield these monthly college savings contribution amounts, if you start saving from birth:
- $300 per month for an in-state public 4-year college, up from $250 per month
- $500 per month for an out-of-state public 4-year college, up from $450 per month
- $650 per month for a private non-profit 4-year college, up from $550 per month
If you start saving from birth, about a third of the college savings goal will come from earnings and the rest from contributions. If you wait until the child enters high school to start saving, less than 10% will come from the earnings, and you’ll have to save six times as much per month to reach the same college savings goal.
How to Benchmark Progress to Your College Savings Goal
To check how much you should have saved by now based on the child’s current age in years, you can multiply the child’s age by a specific dollar amount, based on the type of college. If the amount you’ve saved is at least this product, you are on track to reach your college savings goal of saving one third of future college costs.
Using the same assumptions as for the monthly college savings amount yields the following age multipliers, rounded to the nearest $1,000, if you started saving from birth.
- $3,000 for an in-state public 4-year college, unchanged
- $6,000 for an out-of-state public 4-year college, up from $5,000
- $8,000 for a private non-profit 4-year college, up from $7,000
For example, if your child is 10 years old and will enroll at an in-state public 4-year college in 7 years, you should have saved $3,000 x 10 = $30,000 by now.
If your college savings falls short of this amount, you’ll need to either make a lump sum contribution equal to the difference, or increase the monthly savings contribution by enough to make up the difference in the time remaining.
For example, if your college savings is just $25,000, falling short of the $30,000 benchmark, you’ll either need to make a lump sum contribution of $5,000, or increase the monthly contribution by about $60 a month.
This rule of thumb works because an older child will have a lower college savings goal because you started saving for college long ago, when college costs were lower. The math yields a roughly linear relationship between the age multiplier and age, regardless of the age. It’s a bit magical, but it works.