When it comes to growing a retirement nest egg and saving for college, many young parents with children desire to achieve the "best of both worlds" in life: to retire comfortably and secure their kids with an excellent college education. Very often, the dilemma is: "Should I save for retirement or for the future education of my children?"
While individual and family circumstances vary, you should ensure you are already on pace to save enough for your own retirement before saving for college. Retirement planning should always be your priority — remember there is no accessibility in the form of government loans, grants, or financial aid at retirement.
In addition, consider that by postponing disciplined yearly retirement contributions in employer-sponsored plans [i.e., 401(k), 403(b)] and other applicable retirement tax-deferred retirement vehicles [i.e., Traditional Individual Retirement Account (IRA), Roth IRA], you lose the power of compounding on your side in accruing retirement funds. Thus, the consequences of saving for education before funding retirement can result in having to delay your retirement.
While the current trend of annual public and private university costs increase averages six percent a year, you can plan for a stellar and affordable college education for your children by finding a planner who can assist you with reaching the following goals.
- Make sure you are on track for retirement: Avoid dipping into retirement funds unless necessary. Develop and maintain an investment strategy for retirement planning that is both consistent and sensitive to your flexible young family's needs.
- Keep current on relevant tax laws and market conditions: Using funds in a Roth IRA account for qualified higher education expenses as your contributions to this account can be distributed tax-free at any time. However, you should be aware of the possible tax implications and ramifications on your child's eligibility for financial aid associated with distributing Roth IRA earnings prior to age 59 ½. A financial professional can help you with this evaluation.
- Understand financial aid calculations to help you plan for education: Many savings options exist to finance your children's college funding, including 529 qualified college tuition savings plans, prepaid state tuition plans, Coverdell education savings accounts, and Uniform Gift to Minors Act (UGMA) or the Uniform Transfers to Minors Act (UTMA) custodial accounts. Before choosing and implementing a college planning strategy, make sure you determine the cost of college, your expected savings time horizon, and what kind of realistic return you can earn on the money you save.
Also, you can help minimize the cost of college by stressing to your children the significance of responsibly managing their finances. Reinforce to them the need to take some ownership of their own spending and work on preparing a realistic budget with your child before leaving to college. Have your child track spending and work together to frequently review the budget.
Clearly, while you should not compromise funding retirement for the sake of your children's education, you can still carefully structure a college savings plan aligned with your retirement objectives, and ultimately attain the "best of both worlds."
FPA member Elaine King, CFP®, CDFA™, is the founder of Family & Money Matters Institute in Miami, Fla. FPA member Philip Herzberg, CFP®, MSF, is Director of Media Relations & Public Awareness for FPA of Miami-Dade.