Should you save for retirement first, or save for your children’s college? Many parents tend to put their children’s needs first. Wanting to give their kids the best start in life, parents often choose to fund their kids’ college educations at the expense of their own retirements. But is this a good idea? Here are some reasons why parents should save for retirement instead of college.
Financial consultants point out that students can apply for grants and take out loans for college, while there are no grants or loans for retirement. (A reverse mortgage, though, might be thought of in those terms. So might a whole life insurance policy, since you can borrow from the policy’s death benefit.)
But parents are concerned about the impact a student loan can have on their children’s futures. Forty percent of parents who had their own student loans said their payments have impacted their ability to save for retirement, according to a survey by T. Rowe Price. The survey found that 63% of parents think they took on too much student debt, and 79% want their children to worry less about money than they did while in college.
Nevertheless, here are four reasons you shouldn’t forego retirement savings in order to save for college:
1. You’re missing free money not contributing to tax-advantaged and employer-matched retirement accounts. Because of the employer matching, 401(k) accounts allow your savings to accumulate faster than they would in a conventional savings account. Contributions to a 401(k) account also reduce your federal income taxes, as do contributions to a traditional IRA, and your investments grow tax deferred in both cases.
2. Your retirement savings in IRAs and 401(k)s are not counted as parental assets by colleges when administering financial aid. On the other hand, savings in conventional savings accounts are considered parental assets. By saving aggressively for college, you might reduce the amount of financial aid your child is eligible for, whereas you don’t run this risk when saving in a retirement account.
3. If your retirement account is large enough, you can use part of it to pay for education. You are allowed to withdraw funds from an IRA or 401(k) without penalty for qualified educational expenses. But keep in mind that distributions from a retirement account are considered income in the current year, which may reduce your eligibility for financial aid the following year. There may be additional conditions for taking funds out – check with your 401(k) plan administrator or the financial institution that administers your IRA.
4. By not saving for retirement, you risk becoming a financial burden on your children someday. With corporate pensions mostly a thing of the past, you’re largely on your own to provide for your retirement needs. Your retirement income likely will consist of Social Security and what you have saved. Although many retirees are dependent on Social Security, the average monthly benefit in January 2016 was just $1,341. Unless you are willing to dramatically scale back your lifestyle, you will want to emphasize retirement savings in your financial planning.
But saving for retirement and saving for college don’t have to be mutually exclusive. Ideally, you will meet both objectives simultaneously. Some financial advisors suggest the following plan:
1. Put your first savings in a 401(k), up to the employer match. If you can’t get a 401(k), then open a Roth IRA and contribute to that.
2. Next, pay off credit card and other high interest debt. By retiring this debt, you’re effectively saving the interest rate on this debt, which can be in the double digits – much higher than the interest on a student loan.
3. Third, make sure you have an emergency fund. This is to pay for unforeseen expenses like home or car repairs or medical expenses, or to cover you in case of an unexpected loss of employment. It should consist of six months of living expenses.You don’t want to have to dip into your retirement savings or college funds to pay for living expenses.
4. Finally, put money into college savings. Your best vehicle for this is a 529 college savings plan. Funds in these accounts grow tax free and can also be withdrawn tax free for qualified higher education expenses, including tuition, fees, room and board. You will want to shop around and compare to find the best 529 plan, as terms and fees vary. You can compare 529 plans at www.savingforcollege.com and www.collegesavings.org.
5. Put any remaining savings in a Roth IRA for retirement.
The problem, of course, is that many families can’t meet all of these savings goals at once. A qualified financial advisor may be able to help find the best way to allocate your funds. Here are some things you can consider doing as well to meet a shortfall.
1. Work longer. Nearly half of the parents surveyed by T.Rowe Price said they were willing to delay retirement to pay for college. By putting off retirement, you accumulate more funds and reduce the length of time your retirement savings have to last. You might also consider taking on a second job, seeking a higher-paying position, or having a stay-at-home spouse enter the workforce.
2. Plan to work parttime in retirement.
3. Look for ways to lower your expenses, now or after retirement.
4. Consider a less expensive college: You may have your heart set on your child attending that Ivy League school. But many less well-known liberal arts colleges or state universities can provide an education of comparable quality, at a much lower cost.
5. Think of other ways to reduce college expenses. Your child could work parttime or have an internship while in school, which would provide valuable work experience as well as income. Your child could attend a local college and live at home to save on room and board; take an additional courseload to graduate early; delay college for a year or two to earn money for college; or work at an employer which provides tuition assistance for college classes.
Which strategy is best depends on your individual situation. If you have several children, you will need to save more for college than just for one child. If you expect to retire fairly soon, then you will need to save more for retirement than if you have couple of decades left in your career. If your child plans to become a highly-paid medical specialist or corporate banker, then they will need less financial help and you might be more willing to let them take out student loans.