LIVING ROOM CHAT

FRESHMAN CLASS 2025:

$41,000 to $82,000 

Join our virtual roundtable where we discuss the inflation surrounding education costs and why investors should stay focused on the payoff.

 

2025 will be the year that many of today’s five-year-olds (including mine) say goodbye to mom and dad and say hello to ramen noodles and Proust. $41,325 is the projected yearly cost at a four-year public university, while $82,240 is the projected yearly cost at a four-year private university, according to The College Board, a nonprofit higher education membership organization.1

Inflation is no surprise, but it’s the rate of inflation that drops jaws. Moderate rates of broad-based price inflation—first the result of greater workplace productivity then a global recession—have helped keep interest rates low and the U.S. economy shielded from a deeper contraction. The core Consumer Price Index was running at a 2.2% year-over-year change in November, according to the Labor Department.

Yet pockets of the economy have been exposed to higher prices, including higher education.

According to The College Board, from 2001 to 2012 published tuition and fees at private, nonprofit, four-year institutions increased at an average rate of 2.6% per year beyond inflation. This figure is slightly better than 4.8% in the 1980s, and 3.1% in the 1990s. But for their public counterparts, it’s a different story. The increase is 5.6% per year beyond the rate of inflation, compared to 4.5% in the 80s, and 3.2% in the 90s.

On the other side of the ledger, across the entire U.S. income distribution, average 2010 family incomes were lower in inflation-adjusted dollars than a decade earlier. The largest declines were for families in the lowest 20% of the population, and the highest 5%.

The recession slashed tax collection and endowments, straining college coffers. But one reason tuition fees have outpaced inflation is slower productivity gains in education relative to other economic sectors. The time and effort needed to teach college hasn’t changed all that much in a century. Technology helps, but not to the same degree that tech has transformed, say, manufacturing.

Productivity gains across the rest of the economy drive up average salaries and labor costs. Schools must pay educators more to keep up with rising living costs, even if teaching “output” remains unchanged. Likewise, technologically intensive majors—like engineering—involve higher fixed costs. University budgets try to keep pace with the demand for these degrees by increasing class size, decreasing instructional time, or raising tuition.2

Can families wait for a national fix that may never show up? Perhaps they can’t. Investors should consider saving early and often for their children, although not at the expense of their retirement plan. Financial aid may be an option, but a diverse approach to paying for college may be the most realistic answer.

THE ROUNDTABLE
James Marple, Senior Economist, TD Bank Group
Michael Corr, Line Manager, Education Services, Vanguard
Stephen Jobe, former Executive Committee Member, College Savings Foundation
Rachel Koning Beals, Editor, The Ticker Tape Monthly

Rachel Koning Beals —
Will this rate of education inflation continue?

James  — In the near term, pressure on state and local budgets will likely push publically funded colleges to raise tuition fees in order to cover costs, posing upside risk to tuition inflation. Demand for higher education is likely to remain strong, driving up prices. While state and local government finances will eventually improve, long-term fiscal pressures stemming from an aging population will compete with education for scarce public resources.

Stephen — Private school is perhaps a greater long-term problem, because – while President Obama and others have called for a clamp-down on higher education tuition increases – private schools have no one to answer to but their own trustees. And, for many Americans, four years of private college is already out of reach.

Rachel —
It can seem overwhelming. How do you save for college when costs have been rising faster than income for two decades?

James — Education could yield potentially greater income returns upon graduation, though not all degrees are created equal, and income prospects will vary. Students must understand how student debt factors into their future financial obligations, since loan repayments begin soon after graduation, regardless of employment status. This kind of knowledge passed on from parents can be as useful as the financial contribution to their education.

Stephen — Unfortunately, many investors have been stung by the markets’ volatility the last few years, and consequently may have overreacted in having become more conservative in their investment approach regarding education. Not only have investors missed the stock market rally if they’ve been in cash since 2008, but they are way behind if they’re trying to keep up with the rate of tuition inflation, which has been increasing at a rate of two- to three-times overall inflation, while the annual yield in a typical cash account is barely over a percent. Worse still, many American families are still saving for college in taxable cash management accounts – further eroding their compounding potential.

Michael — In two ways: first, while investors can’t control the cost of college, they can decide where to invest, even if they can’t control their rate of return on the investment. Investors should look at their income and determine how much they can save and begin investing for education as soon as possible. No amount of savings is too small. Remember that every dollar saved is one less dollar that needs to be borrowed to pay for college. Second, consider a 529 Plan as your vehicle for college savings. Earnings on money contributed to a 529 account are tax-free if used for qualified higher education expenses. When choosing a 529 Plan, begin by looking at your home state’s plan (if any) because many states offer state income tax deductions for contributions by state residents. Next, compare costs and performance. Keep in mind that residents are not limited to investing in their own state's plan and the costs associated with 529 plans vary. Another state may offer a plan that performs better, has lower fees, and you may still get state-level tax benefits.

Most plans offer a wide array of investment selections which provide investors choice when investing for college. Furthermore, many plans include one or more age-based choice that have a “built-in” management structure. As the beneficiary approaches college age, the investments gradually become more conservative in an effort to help ensure that the funds are available to pay for college costs.

Rachel —
Are tax-advantaged vehicles like 529s the best way for most families to invest for college?

Stephen — In my opinion, the most compelling reason to take a look at 529s, now more than ever, is to position assets ahead of what is likely to be a rising tax rate environment. We have enjoyed historically low income and capital tax rates for decades, and I’m afraid that is likely to end for most investors shortly after the election.

INVESTMENTS PROS    CONS
Uniform Gifts/Transfers to Minors Act (UGMA/UTMA)
 
Anyone can contribute // No income restrictions // No contribution limit // Investment flexibility // No penalty if not used for college // Not taxed to donor
 
  
 
Irrevocability; ownership cannot be transferred // Beneficiary gains control // Investment risk // Taxable withdrawals // Impacts federal financial aid
 
Coverdell Education Account
 
Anyone can contribute // Flexible security choices // Grows tax-free; no tax for qualified education withdrawals // Minimal impact on financial aid // Estate tax benefit // Also applies to primary and secondary education
 
  
 
Contribution limit $2,000 annually // Income restrictions // Contribution stops at age 18 // Investment risk // Penalty for non-education withdrawals
 
529 Plan
 
Anyone can contribute // No income restrictions // Flexible age limit // High contribution limit // Plans may offer age-based, individual or static portfolio options // Can change beneficiary // State income tax deduction (if applicable) // Tax-free withdrawals for qualified higher education expenses // Minimal impact on financial aid // Accelerated gift-tax benefit // Estate-tax benefit
 
  
 
Investment risk // Penalty for non-education withdrawals
 
Brokerage Account
 
Investment flexibility // No contribution limit // Assets used for any purpose // Minimal impact on financial aid
 
  
 
No special tax treatment // Can add to estate tax liability // No state income tax deduction // Investment risk
 
529 Prepaid-Tuition Plans
 
Anyone can contribute // Can change beneficiary // No income restrictions // Lock-in tuition costs at current rate // State-income tax deductibility (if applicable) // Tax-free withdrawals for higher education // Minimal impact on financial aid // Accelerated gift-tax benefit // Estate-tax benefit
 
  
 
Limited tax-free withdrawals // May require plan state residency // May include age limit // Limited investments // Investment risk // Potentially higher expenses vs. other options // Penalty for non-education withdrawals
 
U.S. Savings Bonds
 
Low relative risk // No fees or expenses // High contribution limit // Can change beneficiary // Assets used for any purpose // Minimal impact on financial aid
 
  
 
No investment flexibility // Tax-free withdrawal restrictions // Early redemption penalty
 

Footnotes:
1.) The College Board and Delta Project “Trends in College Pricing 2011” Inflation is calculated by assuming a 5% increase in cost each year for all relevant expenses, not just tuition and fees. This is an estimate, using 2010 dollars, and applies to in-state residents. Actual costs and rates of inflation may vary.
2.) U.S. Department of Education

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