Saving for college before funding retirement seems like a no-brainer for new parents.
When a new baby is born, you may think, “College is only 18 years away, while retirement is way down the line!” You may even think you’ll never retire at all, so why worry about it now? You certainly don’t want your kids burdened with student loans like you were.
This knee-jerk reaction could pose problems later. Regardless of your gut instinct, saving for retirement comes first. You may be wondering why a financial planner is discouraging new parents from saving for college — aren’t planners always telling people to save for their goals? Not when it comes at the expense of their own retirement.
Here’s why you should prioritize saving for retirement over saving for your children’s college educations:
Retirement is harder to fund.
It’s exceptionally challenging to create an income stream to last 30, 40, or even 50 years. College expenses last only four years and often come during a parent’s highest-earning years.
There are no scholarships, grants, or loans for retirement, either. College funding is an investment in a growing asset — your child’s earning potential. Conversely, retirement funding relies on depleting assets — it is a spend-down plan.
Just because college may come first chronologically doesn’t mean it should be funded first.
Financial planning isn’t linear. People have multiple goals that compete for savings and investment dollars. Rather than immediately opening a 529 plan for a new baby, parents should take a step back and come up with a strategy for meeting both goals, with retirement at the forefront.
Here are 7 ideas on how to fund your own retirement and help your child pay for college expenses:
- Flip flop the “401(k) delay.”
Fund retirement as early as possible — don’t delay early in your career, like many people do. When your child is in college (and you’ve got a solid retirement balance), then delay. If necessary, temporarily suspend contributions to your retirement plan during your child’s college years and use the extra income to pay educational expenses.
- Fund retirement first to take advantage of a lifetime of compounding interest.
Starting early makes a monumental difference. According to the JP Morgan Guide to Retirement (1), an investor who starts funding their retirement at age 35 and funds $10K per year for 30 years until age 65, earning 6.5% interest, would have an account balance of $919,892.
Contrast this to an investor who starts at the beginning of their career at age 25 but only invest for 10 years and then stops contributing altogether. They only put in $100,000 in total (instead of $300,000) but at age 65, their account balance is actually higher at $950,558 than our contributor who started ten years later.
Starting early can make a huge difference in funding a successful retirement.
- Plan to pay out of pocket.
Though not always the case, your peak earning years often hit when your kids are in college. Plan to earmark earnings and bonuses for college funding, and reduce your retirement savings at that point.
- Choose investments that do double duty.
A 529 plan is great, don’t get me wrong. The earnings can be withdrawn tax free for qualified college expenses, and some states even allow a write-off on your state tax return for your contribution. The account, however, is one dimensional — it can only be used for college expenses. Consider investing in accounts that have more flexibility and can provide multiple benefits.
A Roth IRA, for instance, can double as a retirement funding vehicle and college savings account if needed. Anyone can withdraw their contributions with no penalty or taxes at any time. However, if funds are used for qualified college expenses (such as tuition and books,) the IRS allows some special exceptions where account holders can also withdraw the earnings without a penalty.
- Tap into your home equity to pay for college.
Your investment in your home can double as a college-funding vehicle. You may be able to take out a home equity loan or line of credit to pay for college expenses. You could pay the loan off over time, or if you downsize your home, you could use the proceeds of the sale to pay off the loan.
- Invest in rental property now for income later.
A rental property can double as retirement income and a college-funding vehicle. Though being a landlord can be fraught with headaches, those inclined to invest in rental property obviously can use the income for whatever purpose they want. The cost of college can be offset by real-estate cash flow. Then, when your student graduates, the income can be redirected to fund retirement.
- Start a “side hustle” now.
Your little business could turn into an income stream later. You could drive an Uber or Lyft on Friday nights or take advantage of one of the thousands of small business opportunities on the internet — anything from blogging to selling collectibles. A small side business could turn into a big income stream later to offset the high cost of tuition, room and board.
Do a little of all of the above
Your college funding strategy may end up looking like pieces of a puzzle you put together. It could be a jumble of paying out of pocket, pulling from a Roth IRA, taking a loan against a 401(k), using a home equity line of credit, and tapping a “side hustle.” Additionally, your student can apply for every scholarship known to man, take out a few student loans, and max out free or inexpensive units by taking AP classes in high school and courses at a community college.
It may not look pretty, but it can be done without sacrificing your retirement savings.