Is retirement taking a back seat to your children's college financing?
You many want to rethink that strategy.
Your children come first; that’s just the conditioned nature of being a parent. From diapers to preschool to the latest games and tech gadgets, and maybe even to their first car—you’re providing for your children’s present while saving for their future. But how do you avoid sacrificing your future?
Financial planners commonly point out that you can get a loan for college but you can’t get one for retirement.1 So, while children can turn to student loans, grants, scholarships, and part-time jobs to fund their education, parents are limited to early-investment saving to fund retirement.
Too many parents sacrifice retirement savings.
Unfortunately, two recent surveys indicate parents are only too willing to sacrifice their own retirement security for their children’s education. The first survey, from MassMutual, showed that the vast majority of family financial decision makers said that paying for their kids’ education ranked far above saving for their own future medical expenses or retirement. Not surprisingly, only three-in-10 American parents are confident that they are adequately preparing themselves financially for retirement.2
The other survey from T. Rowe Price stated that rather than have their children take out loans, 53% of the parents polled said they’d prefer to tap their retirement savings to pay college expenses. Meanwhile, 49% said they’d be willing to retire later so they could pay their children’s tuition.3
This sobering scenario—robbing Peter (retirement) to pay Paul (college)—can be mitigated by partnering with your children on education savings. Set a budget for what you can afford, after factoring in the necessary retirement savings, then work with your children to find a way to fill in the gaps.
Here are some popular options for getting a head start on saving for college:
- 529 accounts. This is by far the most widely used college savings option. Savings are tax-free for college, and there are no annual contribution, age, or income limits. Contributions to your in-state 529 plan may also qualify for a state tax deduction. There may be limits on the size of the 529 plan account. Also, there can be adverse tax consequences to using proceeds from the 529 plan account for any purpose other than paying for higher education expenses.
- Coverdell Education Savings Accounts. These accounts impose a $2,000 annual limit per beneficiary, but they allow you to self-direct your investments, as you would with an IRA. They also have the added benefit of offering tax-free treatment, not only for college but for elementary and secondary school as well. The tax-advantaged treatment of expenditures from a 529 plan—by contrast—are directed at college expenses.
- UTMA and UGMA accounts. These accounts act as trusts for your child, allowing assets to be transferred to a minor when he or she reaches the age of majority. While they’re not specifically designed to provide for college financing, they are often used for this purpose. Please note that assets transferred to a child in a UTMA/UGMA account are irrevocable. Once the child reaches the age of majority, he or she will control how the money is spent.
- New York Life insurance policies. Insurance benefits from a permanent life insurance policy can help pay for a child’s education in the event of a parent’s death. The available cash value can be withdrawn tax free through policy loans to help pay for education expenses if it’s determined that the full death benefits are no longer needed. Please note that accessing the policy’s cash value through loans or withdrawals will reduce the policy’s death benefit and cash value. An important feature of insurance policies is that their cash value is not factored into federal financial aid considerations.
Cost and effect.
Although there are many ways to save and pay for college, the options for saving for retirement are not that plentiful. In fact, the following three examples highlight ways in which retirement savings are being eroded, which only places those who choose their children’s education over their own retirement in an even more precarious position.
- Shrinking pensions. Many state pension plans are significantly underfunded, with some in danger of being defunded altogether. Private pensions, particularly defined benefit plans, have been steadily declining. Existing defined benefit plans are hampered by the low interest rate environment, which stunts savings, and a longer life expectancy, which increases liability. The only way to make up for these declining retirement assets is for individuals to save more.
- Rising tuition costs. This is likely the biggest challenge facing parents and students: Tuition has been rising faster than inflation for decades. According to the College Board, the average cost of tuition and fees for the 2016–2017 school year was $33,480 at private colleges, $9,650 for state residents attending public colleges and universities, and $24,930 for out–of–state residents attending public universities.4
- Raiding your retirement. Many parents, even those who were early, disciplined savers, have not been able to stave off the need to dip into their retirement savings, whether for educational expenses or to recover from the recession. However, dipping into retirement savings for whatever reason can yield a compounded negative effect of potential taxes on the withdrawal, a lower retirement balance, and the loss of interest on the withdrawn money.
Remember, it’s a team effort.
As noted earlier, the best way to accomplish the dual goals of paying for college and sufficiently saving for retirement is to work together. The earlier you invest in a college savings plan, the better. But there are all sorts of strategies for making college more affordable:
“Have your child start at community college for two years and live at home; have them take AP classes in high school to get a year or more of college under their belt; participate in programs like Peace Corps or AmeriCorps that help pay for college; go to a reasonably priced state school, and get a masters at a name school,” Mackey McNeill, president of Mackey Advisors, suggested to Forbes.com.2
Prioritize your retirement.
This is the child’s potential contribution. But your contribution, as parents, is to prioritize your retirement savings. Because, without a substantial nest egg, you could become a burden on your children when you’re older. If your kids see you placing retirement first, it may teach them about the importance of saving for their own retirement. That could end up being the best payoff of all.1