Families trying to figure out how much to save for college may want to consider Fidelity’s $2K rule to guide them. It encourages parents to save $2,000 for each year of their child’s life.
Another guideline experts often give is the one-third rule, which suggests that families contribute one-third of the cost of college from savings, one-third from current income, and one-third from loans.
Find out more about how each of these rules of thumb works to determine if one might be a good fit for your family’s college financing plan.
- College savings can help offset the amount students must borrow, but families are often unsure of how much to save.
- Rules of thumb like the $2K rule and the one-third rule offer concrete savings goals that aren’t intended to cover the full cost but can help reduce the amount of student loans you take out.
- The $2K rule says families should aim to save $2,000 for each year of their child’s life, so by age 18, you should have saved $36,000.
- The one-third rule recommends trying to save about one-third of the expected cost of college, and then paying for the rest with income and loans.
Where Did the $2k Rule of Thumb Come From?
The $2K rule comes from Fidelity, one of the largest U.S. asset management firms. “Fidelity is always trying to provide families with guideposts. The $2K rule is a good example of that,” said John Boroff, director of retirement and college leadership for Fidelity.
The idea is that the average family is paying for college with a number of different sources of funding, including savings, scholarships and grants, loans, and work-study, Boroff told The Balance in a phone interview. The $2K rule gives them a savings benchmark to build on in an investment account that can grow with compound interest. Doing this can help families make a reasonable dent in the eventual cost of college.
What Is the $2k Rule of Thumb?
The $2K rule says that if you have $2,000 saved for each year of your child’s life, you are on track to cover about 50% the cost of four-year, in-state, public university tuition, Boroff said. This assumes that your $36,000 investment will grow over time in a 529 plan, which is a tax-advantaged college savings vehicle.
According to The College Board’s Trends in College Pricing and Student Aid 2020, it will cost an average of $26,820 for a four-year public university, in-state, students (including tuition and fees, room and board, and living expenses) for the 2020-21 school year. The average sticker price for tuition and fees alone for public, in-state schools will be $10,560.
How Does the $2K Rule of Thumb Work?
To maximize the benefits from this rule of thumb, families should plan to contribute the yearly savings into a 529 account as the child matures.
“The biggest thing is the power of compound interest and growth,” Boroff said. With a 529 plan, your investment grows tax-deferred and will be tax-free when you withdraw it, as long as it’s used for qualified educational costs. “If you open one on your baby’s birthday, you’ve got 18 years to make contributions on that account. The compounding is extremely impactful, especially the longer the runway is,” he said.
What’s more, you don’t have to go it alone because grandparents, other family members, and friends can make contributions to 529 accounts, too. A Fidelity survey in late 2020 found that 81% of parents said college savings contributions would be a good alternative to traditional gifts for their children, so that’s something parents or kids can consider mentioning to loved ones.
The $2K Rule vs. the One-Third Rule
Another popular college savings rule of thumb is the one-third rule. It’s the idea that families pay one-third of the costs from savings, another third using current income, and then the final third using future income (aka, student loans), Mark Kantrowitz, a college savings expert and author of “How to Appeal for More College Financial Aid,” told The Balance by email.
Of course, figuring out what one-third of college will cost can be tricky, but there are tools, including college cost calculators, that can help you estimate, Boroff at Fidelity said. “The sticker price of the school is not necessarily close to the price you’re going to pay,” he said. In some cases, he added, private universities have more leeway in giving grants and scholarships to students who are academically or athletically gifted.
That being said, Kantrowitz estimates that families using the one-third rule should try to save as much as $3,000 per year for an in-state, four-year public college; $5,000 for an out-of-state, four-year public college; and $7,000 annually for a four-year private college.
As you can see, those numbers are a bit higher than what Fidelity’s $2K rule recommends. “I think the $2K rule is too low. It's just not enough,” Kantrowitz said.
Whether or not these savings goals are attainable for you, saving as much as you can and starting as early as possible is key. “Many 529 college savings plans allow automatic contributions as low as $25 per month,” according to Kantrowitz. And Boroff added, even if you didn’t begin saving when your child was born, it’s never too late to get started on a college fund.
Ultimately, the more you save, the less you’ll have to borrow.
According to Fidelity’s 2020 College Savings Indicator study, parents surveyed say they are only on track to cover about 33% of their children’s college expenses.
Grain of Salt
For every rule, there's an exception. Despite what experts suggest, you might need to take these recommended rules with a grain of salt if they don’t fit your situation.
Both the $2K rule and the one-third rule are meant primarily to be guidelines for college savings. Some families may not have the means to save as much as these rules recommend, but any savings (especially when you can benefit from compounding interest over time) can help. Of course, if you can save more, do so.
In conjunction with your chosen savings plan, also research other ways to reduce the cost of college, like taking advantage of financial aid such as grants and scholarships (both need-based and merit-based), and carefully reviewing each school’s financial aid package that’s offered. Some students may also decide to complete the first two years at a lower-cost community college, then transfer to a four-year school.
In the meantime, regularly reassess your progress and goals for your college savings account as higher education gets closer for each child, to help you stay on track.