Balancing Retirement Planning With College Savings

Do you have kids who are in college or will be in the next few years? If you do, you know that deciding between saving for your own retirement or contributing to your child’s college costs is a tough decision at best. College costs continue to soar, with private universities averaging $35,000 per year for tuition, room, and board (or about$10,000 for in-state public schools). College is important, but so is your retirement! Even if you can put off saving for retirement for a few years so you can help with college, the real question is: should you?

Most financial experts will recommend prioritizing retirement savings over contributing to your child’s college expenses. Even though your retirement may be years away, you only have a few options to fund retirement comfortably. Your kids, on the other hand, have federal and private student loans, scholarships and grants, and the option of a part-time job. Instead of choosing either retirement or college expenses, here are some suggestions to strike a balance between the two financial goals.

Check out our archive post on Smart Ways to Pay for College.

Max Out the Employer Match First

The first step to take when balancing retirement and college savings is to max out your contributions to your employer’s 401(k) plan. You can contribute up to $19,000 in 2019 to a 401(k), or $25,000 for age 50 and older, plus employer contributions. Whether the match is one percent or eight percent, you’re missing out on free money if you don’t contribute at least that amount. The other benefit to 401(k) accounts is that contributions are pre-tax

If there is no employer match, or you’ve already met it, consider adding an IRA. The important piece is that you’re saving enough to meet your retirement goals first. Any extra amount goes toward college savings. And never dip into retirement savings to pay for college – ever! Not only will you be hit with unnecessary taxes and fees (unless it’s a Roth IRA, discussed below), you’re also taking away money from your future self that you can never get back.

Below are two popular savings tools for college expenses – and one that doubles as a retirement savings tool.

529 Plans

There are two 529 plans:  college savings plan and pre-paid tuition plans. A college savings plan, which is discussed below, allows you to contribute after-tax dollars to be used toward secondary education or post-secondary education, at any institution. Pre-paid tuition plans, on the other hand, allow you to pre-pay tuition costs for a specific school, thereby locking in tuition at the time of your contribution.

Assets held in a 529 plan count toward the family’s income on the FAFSA, which can affect eligibility for income-based scholarships or grants.

529 college savings plans have several benefits, including:

  • No contribution limits
  • No income limits
  • No taxes on earnings withdrawals
  • State tax deduction

You can contribute to any state’s 529 plan. Locally, Washington, D.C., Maryland, and Virginia have in-state 529 tax breaks.

Here’s a good resource on our blog comparing the differences between 529 plans and Coverdell Education Savings Accounts.

Roth IRA

Another alternative to 529 plans is the Roth IRA. Though traditionally used for retirement savings, Roth IRAs have flexibility that allow them to be used for college expenses. The obvious benefit is that if you don’t end up paying for college expenses, you already have a retirement account set up. You also have more control over the investments. The other benefit is that assets in a Roth IRA don’t count towards the FAFSA, which can disqualify students from certain scholarships or grants based on income.

You can withdraw your Roth IRA contributions at any time and for any purpose without fees or penalties. The caveat is that you withdraw only contributions; investment earnings are subject to taxes and penalties if taken out before age 59 ½ and have owned the account for at least five years. Distributions from Roth IRAs count toward income, and there are annual contribution limits and income thresholds. Check with your CPA or financial advisor to determine what’s best for your particular situation.

One strategy if you’re still a few years away from helping to pay for college is to max out Roth IRA contributions, then put excess money into a 529 plan. In this way, you’re still prioritizing retirement savings, but keeping the option open to withdraw money for college, too.

Have a Conversation

Finally, include your child in the discussion about college expenses. Without overwhelming them, work together to narrow down different college choices, including in-state public schools and community college to meet core requirements. Be up front about your expectations when it comes to parent contributions. When you know what kind of schools are top contenders, how much money you plan to contribute (if any), and how much time is left until a tuition payment would be due, you can start to figure out a monthly savings plan.

Some parents have found success in tying current GPA performance to the level of financial contributions or requiring a portion of allowance or earnings from a part-time job go toward a college fund. It’s also very important to file the FAFSA early; many schools have a limited amount of scholarship and grant money to give out, and it’s often first-come, first-serve.

Saving for college, retirement, or both takes a lot of planning. Be sure to work with your CPA and financial advisor on a plan that works for you, and in a way that maximizes tax savings. Contact Naden/Lean for questions.