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Should You Save For Your Children's Education Or Your Retirement?

In a perfect world, everyone could save enough to fund their children's higher education, as well as provide for their own retirement.  But in the real world, many people struggle to do both, to the point one often takes a back seat to the other.  If this describes your situation, here are some ideas that might help.

The first step is to eliminate excuses for not making a decision.  Procrastination can be costly.  For example, to accumulate $100,000 in five years, you'd have to deposit a little over $1,500 every month in an account that earns 4%.  But with a ten-year time horizon, assuming the same return, you can build up $100,000 by socking away less than half that amount, or approximately $700 per month.

Tax-advantaged saving for either college or retirement relies on the same basic principle - setting aside money that grows tax-free until you need it.

There is also some commonality in how the funds for college and retirement plans can be used.  While those plans that are designed for education must be used for that purpose alone, it is possible to use some retirement accounts for education.

IRA funds

For instance, penalty-free withdrawals can be made from both traditional and Roth IRAs if the money is used for qualified educational expenses.  With a traditional IRA, however, the full amount of the withdrawal remains subject to income tax.  Early withdrawals from a Roth IRA that are used for college expenses are tax-free up to the amount contributed into the plan.  Only the earnings portion of these withdrawals is subject to income tax.

So, does this make IRAs the perfect catch-all for both retirement and college saving?  Not exactly.  One big disadvantage is that you can only contribute $4,000 per year ($5,000 if age 50 or older) to an IRA.  Depending on when you start, this might not be enough to accumulate significant funding for both college and retirement.

Deadline Trap

Be careful of falling into the deadline trap.  It's likely your kids will attend college before you retire.  Since the tuition deadline is closer, you might be tempted to reduce or eliminate retirement plan contributions in the early years of your savings plan in order to focus on education savings.  But a typical retirement will generally last longer and cost more than your child's education.  By putting college tuition first, you could end up with less than you need in your retirement nest egg.

The Best Strategy

What is the best strategy?  If you cannot adequately fund both college savings and your retirement account, maximize your retirement savings first.  There are far more options for financing college, such as grants, scholarships, student loans, and asking the student to pay a portion of his or her own schooling.

Whether it's college or retirement - or both - you need a plan to reach your financial goals.  This is where we can help.  Give our office a call today if you would like assistance in analyzing the options best suited to your circumstances.