Retirement vs. College Savings: Overcoming the Funding Conundrum
by Cathy Pareto, MBA, CFP®, AIF®
Life is a constant juggling act. Every day we juggle tasks, time, people and goals. This is especially true when it comes to balancing financial goals, whereby time is not the scarce resource, but money is. The future can seem especially daunting for young families balancing retirement funding goals and college planning for their children. When a dollar can only stretch so far, how can you effectively plan for both?
Advanced education is vital, but it comes at a cost. Short of saving for retirement or buying your dream home, no other expense has that great an impact on the family finances. College costs increase at about twice the inflation rate. Current increases have averaged 5% to 8%. In fact, it is estimated that by 2020, a four year college education could be as much as $287,000 at a private institution and $133,000 at a public one, based on College Board estimates. Ouch. But, are you really prepared to sacrifice your own financial security during retirement for your child’s education?
As expensive as it is to send junior to college, retirement is even costlier. Sadly, nearly half of American households are not saving at all; and two thirds are not saving enough to retire adequately. Couple that challenge with a desire to fund your child’s education and you may have a serious economic dilemma on your hands.
Paying for School
College expenses are traditionally paid from one of several sources: parent’s current income, financial
aid/scholarships/grants, and parent’s personal savings. Over the past several years, however, a proliferation of college savings programs have been introduced including prepaid tuition programs, including:
- Coverdell Education Savings Accounts. Formerly called Education IRAs, a Coverdell ESA allows you to put $2,000 away each year per child (if eligible), and you can usually invest the money however you like. Distributions are tax-free when used for qualified elementary and secondary education, as well as qualified college education expenses.
- Prepaid Tuition Programs. Prepaid tuition plans are college savings plans that are guaranteed to increase in value at the same rate as college tuition. The main benefit of these plans is that they allow a student’s parents to lock in tuition at current rates. While the state plans vary, if the student attends an in-state public college, the plan pays the tuition and required fees. If the student decides to attend a private or out-of-state college, the plans typically pay the average of in-state public college tuition.
- 529 college savings plans. These plans are a popular choice because they offer the account owner control and flexibility, combined with special income tax and estate benefits. Section 529 college savings plans are tax-exempt college savings vehicles with a low impact on need-based financial aid eligibility. Unlike prepaid tuition plans, there is no lock on tuition rates and no guarantee. Investments are subject to market conditions, and the savings may not be sufficient to cover all college costs. However, with this added risk comes to opportunity for potentially earning greater returns.
Today, there are many choices available for parents, but the most important consideration in planning for college or retirement is to start saving as early as possible. The earlier you start to save, the lower the regular contributions will have to be. It’s never too late, or too early to start.
It’s not easy to be a disciplined saver, but there is no way to survive this funding conundrum without it. In an age where instant gratification is a way of life, it’s tempting to spend today and worry tomorrow. Spend less and save more, while unpopular advice, is necessary advice. The alternative will get you nowhere. So, setting and maintaining a budget will be critical to your success. It’s nice to spoil our children, but do they really need fifty-seven Xbox games in their collection? Is that trip to Disney really necessary every year? Sacrifice today will help assure a better future tomorrow.
Get the Kids Involved
Parents should be straightforward with their children about how much they will be able to afford. If the child wants to go to a “name-brand” school that costs $35,000 a year, but the parents can only afford $15,000 a year, the student can take part in the choice to find alternative financing or go to the more cost effective school. Remind them that if mommy and daddy don’t have enough money in retirement, because they spent all their money on college funding, they should get used to the idea of having them as roommates to support when they’re all grown up. So, run the numbers together to see which universities your family can afford. Compare the costs of attending public vs. private institutions and consider the possibilities for financial aid.
The federal government has made it possible for virtually anyone to attend college, despite cost and despite parent’s income. Student loans and parent loans are readily available at low interest rates and payments are often deferred until the student graduates (for most full time students). Too many families incorrectly assume that they won’t qualify because they feel they are too wealthy, but this is not the case. The application process may be somewhat cumbersome, but the benefits far outweigh the (time) costs.
The best financial aid, of course, is free money. Much of the student financial aid comes in the form of loans, but there are grants and scholarships readily available for that patient enough to search for them, and qualify for them. Check out The College Board for more information about college costs, scholarship search strategies and financial aid.
Working While Studying
Parents who wish to only partially subsidize education for their kids (or not fund it at all) have a number of alternatives. Students can apply for loans, work-study or (gasp) get a job. Asking a college student to work and/or take out loans may
not seem attractive now (especially for the student). But, there is something to be said about a child that works his way
through school. They’re often hungrier, eager and motivated to succeed. Those traits can take you far in life. In fact,
some of the best and brightest professionals have managed to do well in school while also managing a job, present
company included. After all, the kids can get student loans to fund education, but when is the last time you heard of
retirees taking loans to fund their retirement?
Consider a Whole-Portfolio Approach to Investing
Don’t want to bother compartmentalizing your “pots of money”? No problem. Many of my clients have opted for a more
holistic planning approach. A whole-portfolio approach takes into account all of your taxable and tax favored investment accounts. With this approach, you can always earmark certain buckets of your portfolio for certain things. But putting it all together in one portfolio provides a big-picture view of your overall asset allocation. That way you can manage your total portfolio risk at any given time.
This approach allows you to incorporate your various goals, including college and retirement, into the big picture as you plan for future spending needs. You may find that the financial pie is actually big enough for both, or you may need to adjust one goal or another.
So, which one is it—college or retirement? Ideally, you don’t want to sacrifice one goal for the other. Try to balance the
two so you don’t shortchange your future or your children’s in the process. The decision to put your child’s education
before your own retirement is not only an economic decision, but also, an emotional one. Parents feel a sense of
obligation to provide a better way of life for their kids, but if they plan carefully, they won’t have to risk their own well being in order to accomplish this.
The consequences of funding education before funding retirement may lead to inadequate retirement funds or
prolonging your work years. The choice is yours, so choose wisely.
by Cathy Pareto,CFP,AIF Contact Author