This is the second post in a series called Saving With Purpose: Living a More Intentional Financial Life. In this series, I plan to highlight a number of specific savings goals my family has identified we would like to achieve over the next few decades.

Before having kids, both my wife and I agreed we wanted to help our children with their education. My own experience struggling to finish school after taking on student loans, and then charging tuition and books to a credit card, strengthened my position. Like all parents, I wanted better for my own kids.

However, we also want to balance our desire for them to have it easier, our own retirement plan, and my wish for them to learn the value of hard work. One of the mistakes many parents make is that so overload college savings they hurt their own financial plans.

I’ve known parents who saved $200,000 dollars in mutual funds for their kids’ college education, but have zilch in their own retirement plans, a big mortgage payment left from their refinance, and a host of other debts. I will always advise to take care of your own financial plans first, and college savings second. After all, there are no scholarships for retirement.

Having said that, because we are maxing out our retirement plans (more on that in an upcoming post in the series), we hope to also fund our kids’ college needs – at least a large percentage of them. Unfortunately, we got a late start because we put off college savings while paying off our debts. The good news is that we have more to save without debt payments. The bad news it will take some hefty savings contributions to cover college expenses for our oldest, now 10 years-old.

Determining Future College Costs

Hope you are sitting down for this section. College costs are ridiculously expensive, and getting more expensive every year as the rate of tuition costs increases at a faster rate than inflation (between 5%-8% per year). Let’s run some numbers at the website CollegeBoard.com, which has a pretty good calculator.

Assumptions

• Annual college costs, in today’s dollars: $19,388 (4-year public, in-state)
• College cost inflation rate: 5%
• Expected years of attendance: 4
• Percent of costs you plan to cover from savings: 100%

The inputs above yield the following future college costs for both kids:

• Tuition costs per year in 8 years: $28,645
• Tuition costs per year in 13 years: $36,550

For those keeping score at home, that works out to $123,463 and $157,574 (keep in mind, tuition continues to inflate the four years they are in school) in college expenses for our kids. Ouch. Of course, this is sort of a “worst-case” scenario considering most parents don’t have to pay “full retail” for tuition at most schools.

There are a variety of college scholarships, grants, tuition reimbursement plans (if employed), etc. that can help defray some of the costs. But if you’ve learned anything about me from the site, I like to aim big, so let’s work with these numbers for now.

Accounting for the modest amount we currently have in 529 plans, and a 7% growth rate of the funds (which may be a tad optimistic given recent history), that same website suggests we increase our monthly 529 savings plan contributions to $715 a month for our oldest child ($512 for our youngest). Okay, so it looks like we’ll be cash flowing a good bit of her tuition if she doesn’t earn any scholarships, because saving that amount would be a stretch.

So what’s the lesson here? Start saving early! If my daughter was a newborn today, I’d only have to save about half of that monthly amount (roughly $450) to hit a target 18 years out. If I had only taken my own advice ten years ago.

I recently attended a birthday for one of my kids’ friends, and was blown away by the amount of cash gifts they received. Apparently, giving cash is cool again, and I was impressed by the generosity from mostly family members, but a few family friends, too.

My kids occasionally receive a little birthday money themselves, along with gift cards and other small presents from friends and family. Since it is their birthday, we let them take a little bit of money to the store and pick out a toy or game that they’ve been wanting. But we like to encourage them to save the rest of that money in a variety of places.

Local savings account. Savings accounts at a local bank or credit union are practically a financial rite of passage for kids. While they don’t offer particularly good rates, local savings accounts do offer a great way to introduce kids to banking. Take them along and let them fill out the deposit slips and update their balances at home.

Online savings account. As kids get a little older introduce them to online savings account to score a higher rate on their savings, and to take advantage of other features. I like ING Direct (read my ING Direct review) online savings accounts because they update accrued interest daily on their savings dashboard. It’s a powerful lesson on compounding interest for kids to see money being added to their bank account as they sleep. If you aren’t a fan of ING Direct, check out some other top online banks.

529 college savings plan. Most kids are not worried about paying for college until it comes time to pay for college. So I think it is a good idea for them to contribute a little along the way. Invest a little of this “found cash” for your kids in the best 529 savings plan you can find.

Savings bonds. My kids received some savings bonds when they were little to “put up for college.” Later, I convinced the person that gave them to let us convert them to cash and send to the kids’ college savings funds, where I hope the money will get a better return. Sure, they are interesting and colorful and all that, but apart from novelty there isn’t that makes me want to buy and hold them for the kids over the long term.

Individual, kid-friendly stock. I generally dislike the idea of picking individual stocks because I am not good at it, and because I worry over diversification. However, I think it is safe to take a small percentage of your portfolio, say less than 10%, and invest it in a handful of individual stocks you know something about. Same goes for kids. Not long ago we invested a little money in two companies kids are familiar with, McDonalds and Disney. Later, we might add Coca Cola and Mattel to the mix. Be sure to reinvest those dividends, and hold the stock for the long term.  Who knows what a few hundred dollars invested in Microsoft twenty years ago would be worth today.

Where do your kids park their “birthday” money?

The stories are endless.  Joe and Sally saved their entire lives for their kid’s college education, but the recent market downturn has cut their college savings fund in half.  Now they are desperately searching for ways to fund college.  Often times this report is followed up by a tearful high school senior explaining their dream of attending an Ivy League school has been crushed.

I’m a father of two kids, and I know how it feels to want to give your kids everything.  But I honestly think parents are unnecessarily beating themselves up over these college fund balances.  Parents and college-bound kids are going to have to make some tough choices between now and next fall, and the toughest of those choices will be dealing with the financial reality that a large portion of their college funds are gone.

These days most families turn to student loans, particularly those who lost half the value of college savings in a matter of months.  Their story is a cautionary tale for those invested in risky investments too close to a financial goal, but since they all recognize that now there is no sense beating them over the head with portfolio allocation instructions.  No, we are where we are, and we have to figure out where to go from here. Because I generally dislike student loans, the following tips will intentionally leave Sallie Mae out of the mix.

Photo courtesy of StuSeeger

Seven Ways To Fund College Without A College Fund

1. Reconsider your choice of school.  I sound like the guy who doesn’t read his own articles.  I made the mistake of getting hung up on an out-of-state school because my best friend was going there, and I liked the football team, and it was my favorite college town.  Big mistake.  While I do have the ultimate souvenir from those days away at college (my wife), I also came home after 2 1/2 years with a pile of student loans and credit card debt.  After enrolling in a local university it was obvious the quality of education was just as good, and the tuition was considerably less.  Lesson learned.

2.  Ask for help from friends and family.  One of the more interesting concepts I have seen lately to formalize this process is a type of social investing market lead by Freshman Fund.  Students and parents tie the child’s Freshman Fund account to existing 529 college savings plans, and then share the student’s profile with family and friends.  Contributions are collected and deposited directly into the 529 plan behind the scenes (no need to share account numbers, etc. with extended family).

3.  Apply for every scholarship under the sun. I mean that quite literally. If I were a high school junior facing rising tuition costs and a small balance in my college savings fund I would make it my part time job to apply for as many scholarships as possible.  I would enter writing competitions, join various associations, and basically spend every free moment researching scholarship opportunities.  Even if you applied for 1,000 scholarships and 990 of them turned you down, there is a chance those remaining 10 could finance a year of school (or at least offset some of the costs of that first year).

4.  Get a part time job.  This one is a little controversial because some argue that part time work detracts from the college experience, or leads to lower grades. I started working my freshman year to cover books and miscellaneous expenses, and later worked even more hours to pay for an apartment and utilities. Admittedly, it was a drain, but I appreciated things far more than if my mom paid for everything.  I think it helps kids to have at least a little financial skin in the game.

5. Work full time for tuition reimbursement.  Many companies offer tuition reimbursement plans to their employees.  Start by researching companies in the field you are ultimately interested in studying. Most company websites offer a list of perks included in their benefits package, and if you have questions about tuition reimbursement eligibility contact the company’s human resources office (or recruiter) usually listed on the job search page.

6. Live at home and stay local, or commute a short distance. Room and board can add significant costs to already inflated tuition costs.  If you are short on cash you might be able to pull off tuition-only and stay and stay on the “Mom and Dad” meal plan. As a compromise, at least consider living at home your first year or two and then look for a reasonable off-campus option for the final years at school.

7. Take a year off to save up the cash. Again, not a popular option for most high school seniors eager to get started on college life. But families need to be realistic; if the money isn’t there it just isn’t there.  And with many people being laid off, or at least fearing they may be laid off, most parents are reluctant to try to cash flow tuition at an expensive school.  It might make sense to take a year off, work full time while living and home, and save every single dime you earn towards the next year’s tuition. I wish I had chosen this route – in fact, I ultimately did. I went to school right away for a couple years, returned home and worked for a couple years, and then wound up working my way through my remaining time at school.

Again, I want to stress to those parents and students out there who might be reading this that it is not healthy to play the blame game. Many parents are mad at themselves for not rolling funds into cash last year, and many students are equally mad at parents for losing so much of their college fund.  Being mad at yourself, or resentful towards your parents accomplishes nothing.  Now is the time to pull together as a family and work to find a solution that works best for everyone involved.

High school seniors, resist the temptation to take out huge student loans. I know the money is there, and you don’t have to pay it back for a few years, but you will have to pay it back.  When you graduate college you will be filled with the excitement of getting started in your career, and finding your first home. Don’t spoil it by tying a noose around your neck and hanging four years of student loans from it. Those loans will limit your options, and are often the gateway to other forms of debt such as credit cards and car loans. Make the sacrifices now so you don’t have to make them later.  I promise, ten years from now you won’t regret it.