Finding a balance between retirement savings and college savings represents a challenge most families need help managing. If you feel overwhelmed, you're not alone. The struggle is real, especially when parents consider whether to withdraw from their retirement savings to pay for college.
Generally, Parents Should Save First for Retirement and Then for College. Why?
Retirement is most often cited as the number one goal for long-term savings in large measure because of the uncertainty around retirement age and life expectancy. Many singles get a head start on retirement planning by beginning before they get married so they have many years to save - well beyond the typical eighteen-year period leading up to college for their children.
This incubating nest egg sometimes creates a false sense of security for parents who may feel comfortable drawing down retirement savings to help fund their child's college dreams. These withdrawals often come within 15 years of retirement producing a double negative: reducing the amount of retirement savings and the possible earnings thereon. Reducing the nest egg just before retirement can be dangerous and should be avoided.
For those not yet 59 1/2 years old, drawing down retirement savings for college expenses will also typically result in a 10% early withdrawal penalty and a requirement to pay taxes on the distribution making it less of a financial plan and more of a knee-jerk reaction.
Here's How Families Successfully Manage Both
Plan for your retirement first: Airlines tell us to put on our oxygen masks before caring for our children and the same is true here. Taking the time to create a vision for your retirement and the financial plan needed to secure your future is critical - not just for you, but for your children as well. Parents do not want to burden their adult children financially and those with a retirement plan are less likely to need financial support in the golden years.
In addition to the tax benefits provided by Traditional and Roth IRA's, 401(k) and 403(b), retirement savings are also often boosted by matches from employers. These are substantial benefits over time. Contributing an amount equal to at least the employer match gives you an immediate 100% return on that investment. You may consider redirecting savings to education savings above the match, so you have the best of both worlds - doubling your retirement contribution and establishing savings for college. This could work if the amount you are saving for retirement meets your projected needs.
While you cannot predict the future of your child's academic plans, you do know and understand your own future financial needs better than anyone else. It is also important to remember that you can't borrow to retire, but your children can make choices to attend less expensive colleges or borrow for college.
Play the Long Game With College Savings
Establishing a college savings account, either a 529 College Savings Plan or a Coverdell Education Savings Account, works very well for most families. These tax-advantaged savings plans can be established with minimum investments usually around $25 and permit tax-free earnings and distributions for funds used to pay qualified education expenses. Stay motivated by reviewing your savings progress as consistently as you would review your child's report cards.
Enlist Others To Save for College
Help your child develop their role as an active saver for college. As early as Kindergarten, teach your child financial literacy skills by having them save, spend, and share their allowance, and have them contribute some of the cash gifts they receive to their college savings. Teaching youngsters the value of money and how it is used will pay dividends as they mature. Once the child begins working part-time, they should invest in their future by contributing a portion of those earnings to their college savings account. With skin in the game, they will make better choices when it's time to pick a college.
Other family members can also contribute to your children's college savings accounts. Grandparents, aunts and uncles, and friends may gift directly into 529 accounts or use services such as The Gift of College to purchase gift cards that can be deposited into a child's 529 plan.
Enlisting relatives and your child to help with college savings is a great opportunity that does not exist when saving for retirement.
Take advantage of the tax benefits inherent in both the retirement and college savings plans, contribute what you can consistently and rest well knowing that you did the best you could for your retirement and your children's education.