Due to things like the time value of money, market risk and asset management fees, many qualified and unqualified college savings plans are expensive and can erode your hard earned money even if you’re doing it for all the right reasons.
Let’s say your child is 6 years old today. When your child is ready for college in 12 years, you will have to pay about $7,250 after tax each month for private college. I based this on $348k, which is the total cost for 4 yrs of private college in 12 years time (here is the online college savings calculator I used). Believe it or not, some people can pay that much each month.
Think about what your household earnings should be at the time your child goes to college. If you expect your earnings to go up each year and those of your spouse, you may be able to pay for most or all of college on a monthly basis at the time your child is actually in college, which is the smartest way to pay for it if you can do it.
A dollar earned now is worth more than a dollar earned later, also known as the time value of money. A dollar earned now and put in a savings fund (even a qualified one that grows tax free) is not only subject to inflation, but also asset management FEES (see my article on 529 plans and fees). That dollar in the future could be worth significantly less than $1 now even if you do as well as the market over the period.
If your child happens to start college a few weeks after, say, the bankruptcy of a large investment bank (Lehman Brothers) or other market bubble bursting, your savings could be worth significantly less if not wiped out (it’s called market risk) and there’s no way to avoid it if you’re in the market.
Because of the time value of money, fees and market risk, you are better off if you can pay for your child’s college on a monthly or quarterly (even yearly, if you get a big bonus) basis.
So who should save? People who do not think their combined after-tax household income could support $7250/month on school, which is most of us. But, you wouldn’t believe how many people are saving like little misers now when they CAN afford the $7,250/month (or close to it) in however many years it takes for little Susie to get to college.
People who either plan to retire, start their own business or move to a less demanding (and therefore less well-paying) job before their children are finished college NEED to save for college. If you see your income going up and even peaking when your children are in college, and you KNOW you will have $7,250/child/month after-tax to devote to college, then you should not bother saving in a 529 or other college plan. It is a waste of money in fees and inflation erosion.