Medical school is expensive. Not only financially, but there’s a great expense in time, effort, and perhaps some sanity. While you may be pushed to the brink on your commitments of time and effort, the financial commitment is on a constant rise. Physicians face a particularly difficult path to paying for their own education. When you consider the cost of schooling, then the likelihood of that debt growing during training, you could be paying a significant portion of your income toward debt for up to twenty or twenty-five years. Now consider your kid’s college cost. Their undergraduate school will likely be more expensive than your medical school. So it’s important to consider your attitude toward helping them pay for their education now. I’ve created a college cost calculator to help you determine what you could be paying for your kid’s college cost and how to pay for it.
I’ve discussed in a previous post about the concept of “time value of money” and how it applies to paying down debt and saving for future financial goals, namely retirement. With the goal of paying for your kid’s education, time value of money doesn’t have as long to work it’s compounding magic. What’s worse is that tuition inflation has historically outpaced the consumer price index by two times¹! According to BigFuture², the average annual private school tuition is currently $32,410, public 4-yr school tuition is $9,410, and public 2-yr school tuition is $3,440. With a six percent rate of tuition inflation, tuition for a child born this year would be $92,509, $26,859, or $9,819 respectively for each type of tuition. To be fair, those are future dollar figures. Adjusted for inflation at three percent, those costs would be $52,757, $15,318, and $5,600. Estimating what your kid’s educations will cost has a lot of variables to consider. How many kids? Which type of school? How many years and when will they start? The college cost calculator I’ve built will project out your costs for each of these variables.
With the disadvantage you’re faced with, you need all the help you can get. One way is to increase the tax efficiency of your savings. Putting money aside in a regular taxable account isn’t the most tax efficient option. Sure, if you invest in individual securities using a buy and hold strategy, you won’t incur taxes until the positions are sold, and then it’s at the lower long-term capital gains rate. While that route can be effective, there are better options.
UTMA or UGMA Accounts
The Uniform Transfer to Minors Act and the Uniform Gift to Minors Act provides a somewhat more tax efficient vehicle to savings for your kid’s education, or really, any financial goal for your kid. These are custodial accounts where you make an irrevocable gift to your minor child. The tax rules around these accounts allow the first $1,050 of unearned income to be tax exempt. The next $1,050 is taxed at the child’s tax rate, then the remaining unearned income is taxed at your rate. If you use this tax advantage to recognize $2,100 in gains each year, this could significantly reduce future long-term capital gains tax down the road. There are major drawbacks to these accounts, though.
- When your child is of age, usually 18 or 21 depending on the state you’re in, he or she can do anything they want with it.
- If your child applies for financial aid, having assets in their name will lessen their eligibility to receive aid.
The best vehicle to use in saving for your kid’s college cost is a 529 plan. These plans work very similarly to a Roth IRA. They are funded with after-tax dollars, investment gains have tax-deferred status, and distributions are tax-free for qualified educational expenses. They also have a few other key features that make college funding a lot more effective.
- While contributions are considered gifts and subject to gift tax laws, you can gift up to five years worth in one year to get more invested sooner. This year the gift tax exclusion amount is $14,000, so you can contribute up to $70,000 in one year, $140,000 for couples.
- You retain ownership of the assets. What if your child doesn’t go to college? What if they do but are awarded a scholarship and they don’t need all or any of the savings? The owner can name a new beneficiary within the original beneficiary’s family.
- Because assets are retained by the owner, It will only have a minor affect the child’s ability to receive financial aid.
- There’s another type of 529 plan that allows you to purchase in-state tuition credits now for use in the future. It limits your kid’s options but is more precise in knowing exactly how much tuition will be covered.
Educational IRA (Coverdell Educational Savings Account)
Educational IRAs are similar to 529 plans in that they are given the same tax treatment. The problem with these accounts for physicians is that there is an income limit on contributions. If you’re filing single, the phase-out is between $95,000 and $110,000, double that for married filing jointly. Even if your income is below the phase-out, the most you can contribute in a year is $2,000.
The college cost calculator assumes you are using a 529 account.
Asset Allocation Strategies
The last piece of the puzzle is to determine an investment strategy. We already know that time is limited, so you want to squeeze out every bit of performance as you can. So what should you do? Invest in gold and silver? Well, let’s not get too out of hand. You do want to get aggressive with an all-equities portfolio early years of the child’s life. As you approach starting school, gains should be protected by gradually shifting the allocation from equities to bonds and cash as demonstrated below. I should say that my college cost calculator isn’t quite so sophisticated as to allow you to change the asset allocation along the way. It’s just meant to give you a general idea of how much you should be saving each year to achieve your goal of funding your child’s education.
What’s Your Philosophy?
Lastly, I’d like to briefly touch on the softer side of funding your child’s education. You need to take some time and really think about your philosophy towards providing for your children. In my own experience, my parent’s philosophy was to encourage us (my sibling and myself) to get as educated as possible by paying 100% of our tuition. They contributed towards our living expenses too but did put a limit on that. With a physician’s income and a frugal lifestyle, they were able to make good on that commitment. I’m grateful for what my parents did, but the landscape has changed and I see value in requiring your kids to have some skin in the game. Too many kids go to college just because that’s what you’re supposed to do. Too often they don’t learn specific skills that they’ll need to stand out in their chosen career. Sure, they get a degree, but that’s the norm now. By requiring your kids to contribute, even just a little, will help them to really think about what they want to get out of their college experience.
So what do you think? Does the college cost calculator bring to light the enormous hurdle our kids face to get educated? What’s your philosophy towards paying for your child’s education?