Summary: Every parent wants to provide the best for their children, and with college costs continuing to rise we do not want our children to be straddled by debt or even be hindered to attend the college of their choice due to financial constraints. This, along with the thinking that retirement is so far away, leads many to ponder if it makes sense to divert funds from their retirement savings to save for college. In short, the answer is no. There are many ways in which a student can fund or work to reduce college expenses, which do not exist for your retirement years. Continue reading below for a more in-depth look at the options available and what course of action makes most sense for you and your family.
Have you ever flown in a commercial airplane? Odds are pretty high the answer is yes. At the onset of the flight, you will inevitably be told in case of emergency to place the oxygen mask on yourself first, and then help others. The point being you are of no help to anyone in this situation if you yourself are incapacitated, and in fact you may become a liability. This same analogy can be applied to your finances as well.
As parents, you may feel compelled to do your best to provide the best of opportunities for your children’s’ future, and to limit any financial constraints associated with these opportunities, particularly when it relates to higher education. This is why the decision on how to allot additional savings appeals to both your logical and emotional reasoning. This blog will help to provide a framework to help you and your family answer the question of should you devote your savings toward college or retirement, understanding that no two situations are alike and what may be best for you, may not be the best option for others. We also understand the presence of debt like student loans and the pursuit of other goals like a new home purchase or practice acquisition/startup may redirect much of your savings, as such this blog will focus primarily on the decision of saving for college vs. saving for retirement.
Paying for College
In case you’ve been living under a rock, you are likely aware of the rising costs of attending college. The chart below shows the published tuition and fees by sector, adjusted for inflation, relative to 1989-90 published prices. You can see that the cost of attending college in academic year 2019-2020 is almost 3X the cost as academic year 1989-1990 after adjusting for inflation.
SOURCES: College Board, Annual Survey of Colleges; NCES, IPEDS Fall Enrollment data.
This can certainly create some anxiety, and since college will most likely occur sooner than retirement, you may think this should take priority. However, there are many ways in which one can save and/or pay for college. We explore some of these below:
Student loans, while not a preferred option for many, can be a reasonable paying for college. Just be sure to be mindful of the type of school your child plans to attend (public vs. private), their desired field of study and entry level salary, and make sure they fully understand the type (government vs private), amount, and repayment options of the loans they take out. Performing your due diligence is a prerequisite when it comes to student loans.
Scholarships are available for almost every student, and can be offered through a myriad of organizations (local groups, nonprofits, educational institutions, etc.). Speak with your guidance counselors and financial aid offices for more information on how to locate these scholarships and information on how to apply. For those located in the state of Georgia, the HOPE Scholarship can be of great benefit.
Many federal, state, and college-based grants are available to students with both need-based grants and merit based grants available.
Financial gifts used for tuition payments paid directly to the school are not subject to the federal gift tax and can pay 100% of a child’s college tuition costs, bypassing the $15,000 per year gift tax limitation. Funding a 529 plan or using Roth IRA contributions can also provide tax free assistance.
Taking AP courses while in high school to earn college credit or attending a community college for 2 years and then transferring to a 4-year school (ensure the courses you take are transferable) will also help to defray the expenses associated with college.
Finding part-time jobs, whether on campus or off, can supplement costs as well. Just be sure the job does not impede your academics, which is the purpose for attending college!
Why Retirement Takes Priority
You probably noticed that of all the options available to pay for college, only one of them, employment, also applies for retirement (but if you NEED to work, does that really constitute retirement?). Retirement may be much further in the future, but with advances in health care and increased longevity, it is not unfathomable to envision a retirement lasting 25-30 years. To tie in the analogy used in the opening paragraph, if directing the majority of your savings toward college results in you falling short of meeting your retirement income needs, rendering you to possibly be dependent on your children in the future, does this really achieve your desired outcome of providing for your children?
Now, depending on the amount of excess cash flow, there are a few options to consider which may benefit both goals.
This has been taught and written ad nauseum, but is one of the most important considerations when it relates to investing. The younger you are and the sooner you begin saving, the better position you will be in, regardless of the goal.
As you will see in the chart below, assuming a 7% annual rate of return, if Jack invests $200 per month beginning at age 25 and ends contributions at age 35, he will amass a greater value than Jill, who begins contributing $200 per month at age 35 and continues until age 65. Even with 3x the contributions of Jack, Jill still falls short of Jack.
You have heard of and possibly even have a Roth IRA. This type of account is contributed with after-tax dollars and grows tax free. Since contributions are after-tax, you are able to withdraw contributions at any time, with no penalty or tax consequences. How does this relate to our topic? After taking advantage of your employer retirement plan and company match, you can redirect savings into a Roth IRA (subject to limitations), providing savings which can benefit both your retirement and college savings. Using the 2021 Roth IRA contribution limit of $6000 per person, and assuming you make contributions for 18 years beginning when your child is born, this provides for over $100,000 in tax free money you can use for college (this number would be double if both parents contribute the maximum). If your child is able to take advantage of some alternative college funding options listed above, this would allow you to keep the funds invested in your Roth IRA for retirement.
Open a 529 College Savings Plan Before Child is Born
529 College Savings Plans are designated college savings accounts, functioning much like a Roth IRA. They are funded with after-tax dollars, grow tax-free, and if used to pay for higher education expenses can be withdrawn tax free. They are also quite flexible in nature and can be transferred or rolled over to another family member. To take advantage of the benefits of time, an individual could open a 529 plan in their name, make contributions, and then transfer at any time. This could be a great option for those who plan to have additional children. As noted earlier, the sooner you are able to begin investing and have your money grow, the greater the benefits. It is not necessary to open a 529 plan in the state which you reside, however depending on your state you may be able to eligible for a tax deduction for your contributions. Be sure to review the plan details and investment options when deciding on a 529 plan.
Andrew Langdon is a CERTIFIED FINANCIAL PLANNER™ and the founder of VetWorth, a fiduciary fee-only financial planning firm dedicated to serving the unique needs of veterinarians and their families.
Disclaimer: This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. I encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Andrew Langdon, and all rights are reserved. Read the full Disclaimer.