Indians have always revered education as a means of financial independence, social mobility, and generational wealth. To many Indian parents, educating their children is also considered a moral duty, one which they are willing to make through hard work, savings, and sacrifice. Today, both Indians and NRIs spend hours strategizing how to get their children into top educational institutions. From playing sports to practicing instruments to competing in science fairs and spelling bees, NRIs are willing to do much to help their children gain an edge in the college admissions race.
The Need for a Well Thought out Plan
But what happens when your child gets to the finish line? Do you have adequate savings and assets to ensure your child can go to the college or university of their choice? Or will financing your child’s education be an obstacle to their dreams (and yours)? According to this 2018 report by Sallie Mae, one of the largest student lenders and financial aid providers in the US, 50% of families are surprised by the considerable cost of obtaining a college degree. Even more worrisome, 60% of families do not adequately plan for how they will pay for college before their student enrolls.
This data is not surprising, given how quickly college costs are rising. Between 1989 and 2016, the cost of a four-year university grew by an average of 2.6% per year(adjusted for inflation), much higher than the 0.03% real average wage growth in the US during that same period.
The Ever Rising Tuition Costs
According to US News & World Report, the average cost of tuition and fees in 2018-2019 was $9,716 for public in-state universities, $21,629 for public out of state universities and $35,676 for private schools. These numbers exclude the cost of room and board, let alone other costs such as travel, activities, and other fees, which can add $12,000 per year.
India, too, is not immune to tuition inflation. The cost of tuition at IIMs increased by 4x between 2007 and 2018, while the annual cost of tuition at IITs has risen 8x from INR 25,000 in 2008 to INR 2,00,000 in 2018.
So, what is a parent to do when the numbers seem overwhelming? Whichever country your child plans to go to for higher education, it’s never too early to start saving for college.
Calculate the Required Savings for Education Costs
The first step is figuring out how much you need to save. This is not just a matter of multiplying the tuition numbers above by four years. As a matter of fact, for US universities, parents are rarely expected to cover the full cost of tuition. In addition to family contributions, some of those tuition dollars will be covered by scholarships, grants, and loans. The out of pocket cost to the family, then, excluding these amounts is called the net cost. Also note, H1B/L1 visa holders are generally not eligible for federal student aid, or most scholarships, which usually require citizenship or permanent residency.
According to the College Board, the net annual cost for four-year private university tuition plus room and board is $27,160. This means that the average person will need to cover over $100,000 in costs per child. And if your child is a few years away from college, given tuition costs are expected to continue to rise, that number will be even higher.
We suggest two ways to calculate how much you need to save now to be ready for those future expenses.
The $3K Rule
A simple rule of thumb developed by Fidelity Investments is to save an amount equal to $2,000 every year from birth. If your child is older, multiply your child’s age by $2,000, which is called the 2K rule. Assuming you have no savings earmarked for college tuition, this is the amount you need to invest now to cover half the average cost of a four-year degree from an in-state public university. But given the higher importance attributed to children’s education by NRIs, we recommend setting aside $3000 per year per child.
This means if you have a ten-year-old, you need to have $30,000 ($3,000 x 10) invested today and invest an additional $3000 every year hence. Then as your investment grows, so will your future college savings.
Let us assume that your child goes to college at 18, and your $30,000 plus $3,000 per year investment grows at 8%, the long term expected return from a diversified investment portfolio. Over that eight years, your investment corpus would have grown to $87,438, while four years of tuition will have grown by 5.3% (the annual growth rate in the last 27 years) annually from $38,864 to $58,611. Add in approximately $48,000 for four years of room and board, and you will need $106,611 by the time your child enters university. If you started with $30,000 when that same child was ten years old, your foresight and discipline would have covered roughly 82% of your child’s college costs by the time they are ready to enroll.
Example of $3K Rule
The Percentage of Cost Rule
An alternative way to calculate your required savings amount is calculating a percentage of your child’s projected future tuition requirements.
For the same child, assume they will go to a private university in eight years. Take the current tuition of $35,676 and assume it will grow at 5.3% for the next eight years. This gets you $53,803 or $215,215 for four years. Add in $12,000 per year for room and board, and your future costs will be approximately $260,000. Say you want to save 60% of this amount, you will require $156,000 in eight years to cover 60% of your child’s costs for a four-year degree from a private university. Now working backward from that amount and assuming your funds will grow at 8%, you will need to have about $55,000 invested today and additionally invest $ 5000 every year to cover 60% of future expected tuition in eight years. As you can see, the required savings amount for four-year private university education is more than double that of an in-state university.
Example of saving 60% of the Projected Cost
As you can see in both the above examples, the savings cover only a part of the cost of college. If you would like to cover a larger portion of the education expenses, you will have to increase your investments accordingly. Once the investment amount has been set, it’s important to invest in the right accounts and the right mix of assets.
529 College Savings Plan
529 plans are state-sponsored college savings plans that confer significant tax advantages. Although the investment amounts are made with post-tax dollars, once this money invested in a 529, investment gains are not taxed, as long as the funds are used for tuition or education-related expenses. This plan is best for permanent residents or citizens who intend to study in the US.
For H1B visa holders whose children may want to return to India to study or may not have a definite time horizon in the US, a 529 plan may not be a good option. If 529 funds are not used at a qualified institution eligible to participate in federal student aid programs, then the money will be subject to tax on any investment gains in addition to a 10% penalty. Though there are a number of international universities qualified for the usage of 529 funds, none are located in India. As such, a regular investment account may be more advantageous for some H1B investors.
For anyone investing for future education costs, whether in India or the US, the investment mix should evolve as your child approaches college. Investments should be more heavily weighted towards growth when your child is younger when you have a longer timeframe before you need the funds. As your child nears their high school graduation date, investors should shift to a more conservative investment mix focused on capital preservation, to ensure they don’t lose their initial investment or gains due to stock market volatility.
Regardless of where your child goes to college, a thoughtful financial plan is the first step to ensuring you can fund your child’s future educational needs. By calculating what funds your child may need for future study and investing wisely, you will be prepared to help them live their dreams.