Saving vs. Borrowing

When you understand the long-term financial realities of borrowing, you can make an educated choice about how much you’ll need to save versus how much you need to borrow.

Using both loans and savings to pay for college is a pretty common strategy today, but there are definitely factors you’ll want to consider when measuring the importance of college savings against other competing financial priorities — including the impact of debt on the student’s lifetime earning potential and how saving versus borrowing stacks up dollar for dollar. The good news is saving doesn’t have to be painful. There are many best practices which can make saving an easy, budget-friendly process.

Saving Now or Borrowing Later

When it comes to how you pay for school, as much as possible it’s better to save now than borrow later. When you’re saving, interest can work for you. When you’re borrowing, interest can work against you. In the same way that compounding interest over a long period of time can significantly increase your savings, repaying interest on a loan over a long period of time can significantly increase your debt.

Depending upon the interest rate and repayment terms, you can pay as much or more in interest than the original loan itself. When you add in the fact that student loans are often difficult to pay with most entry level salaries and the impact they can make on an individual’s lifetime wealth, saving more now just makes smart financial sense.

529 Funded vs. Student Loan Funded Education: $113,000 vs $276,383

This chart hypothetically assumes four years of college (current annual cost of $20,000) for a child born today. To meet that expense 18 years from now, you would need to save $448 per month (from birth) in a 529 plan — totaling $207,456; $113,000 in contributions and $94,456 in earnings, assuming a conservative 5 percent college cost inflation rate and a 6 percent annual investment return. If the same funds were borrowed to pay for college rather than saving and investing your child would graduate owing about $276,383 in loans. This translates into a monthly payment of approximately $2,303 over 10 years, assuming a 6 percent loan interest rate. In other words, college would end up costing an additional $163,383, or more than double in out-of-pocket costs, than if you had saved and invested in advance. This chart is for illustrative purposes only. Account value in the Investment Options is not guaranteed, and will fluctuate with market conditions.

Making Saving Easier

When it comes to saving, there are a few tips and tricks that can make the process smooth and worry free.

Save Small Amounts Weekly or Monthly

Don’t try and save huge amounts that will adversely impact your available income. Just save a small amount and invest it steadily. It’s not about trying to cover the entire cost of your son or daughter's education — it’s about saving as much as you can within your means.

Set Up Recurring Contributions

A good way to help your account grow is to make sure it’s a normal part of your monthly bills. Establishing recurring contributions makes saving easier and predictable, so it becomes a regular, expected expenditure within your monthly budget.

Set Up Direct Deposit from Your Paycheck

If you’re like most people, when your payment is automatically deducted from your paycheck you'll hardly notice the difference. In the meantime, your account can be quietly growing year after year. This is a great, stress-free way to help build your account.

Use Your Tax Refunds or Other Annual Lump Sum Such as a Bonus or Inheritance

While investing small and steadily can help build your account at a regular pace, occasional lump sums like a tax refund or other financial windfall is a great way to leap forward. Adding just one lump sum a year in addition to normal payments can make a big difference in how fast your account potentially grows.

Invite Friends and Family to Make Gift Contributions

Friends, grandparents, aunts and uncles all want to see your child succeed as much as you do. Let them know about the account and how easy it is to make a gift contribution. Chances are they’ll want to help — even more so once they learn that giving can reduce the taxable income on their estate.

Get Your Kids to Participate

Does your son or daughter have an allowance, stipend or part-time job? Encourage them to invest a portion of that money in their college savings account. Helping to pay for your own education nurtures a greater appreciation for the money and helps build a sense of fiscal responsibility early in life.

Balancing Saving for College with Retirement

While certain types of investment accounts like a classic IRA or Roth IRA can be used to pay for college, their express purpose is to save for retirement. You don’t want your child’s education to come at the cost of your retirement nest egg, so it’s better to save in separate investments and avoid using your retirement fund.

Remember, it’s not about covering all the costs for your child’s college — it’s about saving as much as you can. But you still need to look to your own future. You don’t want to have to work longer or be a burden upon your children as they're building their lives. When it comes right down to it, your children can get scholarships or financial help to pay for school, but as a retiree, you won’t have any such options.