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Should Parents Sacrifice Retirement Saving For College Tuition?

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An undergraduate degree from a respected university—it’s all but a necessity in today’s job market, and post-undergrad education is becoming common even among entry-level applicants. But is that shiny degree really so important that students’ parents should put off saving for retirement, or worse, liquidate their current accounts?

In fact, according to a recent T. Rowe Price poll of parents with kids 15 and younger, it might be with 52 percent of respondents saying that it’s more important to save for their kids’ college than for their own retirements, and 53 percent saying they’d rather pull money from their retirement savings than allow their children to take student loans. Granted, 62 percent also said that investing in their kids’ college education is “actually an investment in my own retirement,” but financial experts tend to disagree.

“It’s a case of robbing Peter to pay Paul, and these parents deplete their own savings and don’t have enough for their own needs” said Mike Tove, a Cary, North Carolina insurance agent. “They don’t realize the impacts of inflation, and they’re not counting on the fact that Social Security won’t be enough.” Not to mention, pulling money out of a 401(k) or IRA before age 59½ leads to penalties and potentially higher tax bracket— a two-fold hit to a couple’s savings that will make it even more difficult to make up for lost time.

In fact, that lost time is something too few couples consider, and the opportunity costs of choosing tuition over retirement savings are astronomical. “If you pull from a retirement you’ve built up for 18 years or more, you’re setting yourself almost back to square one,” said Craig Meyers of CR Meyers and Associates. Considering that the average parents of a college-bound child may have another fifteen to twenty years in the accumulation phase, an early withdrawal could halve the amount of time they have to reap returns on that money.

“I do workshops on this,” added Tove. “These people’s future is  ‘welcome to Wal-Mart.’”

Parents often make these sacrifices under the assumption that their kids will support them later on, but that assumption isn’t always clear, and it certainly isn’t reliable. “These parents have to realize that if they’re going to pull from their retirement for a certain number of years, the kid’s going to have to fund them in retirement for even more years,” said Meyers. Average annual tuition costs exceed $14,000 per year at public universities and $37,000 at private schools, according to the National Center for Education Statistics, and inflation and the loss of compound interest on those funds will set parents back far further. Even for kids with excellent high school records and bright futures, it’s tough to bank on their abilities to support Mom and Dad after college.

Fortunately, there are more efficient ways to fund a child’s college education – ways that won’t require parents to sacrifice their own futures for their children’s. “One person in the family shouldn’t take a step forward if everyone else has to take two steps backward financially,” said Kyle Winkfield, President of the Winkfield Group. It may make sense to cut down slightly on retirement savings to contribute to a college fund, but liquidating a retirement account should be out of the question.

As for better options, the ideal strategy starts sooner than later. “If you put away just 100 dollars per month from the second the child is born, even without interest, that’s over $26,000 by the time the child is 18” said Meyers. “It may also make sense to dial back 401(k) savings in favor of college savings if you’re not getting a match. There’s less advantage there, anyway.” Given rising college costs and the growing necessity for graduate education, Meyers advises a safer savings rate of $200 to $300 dollars per month when possible.

Contrary to popular opinion, however, the tax-qualified 529 plan isn’t always the best savings vehicle. If the assets are used for anything other than qualified education expenses, the contributors have to pay both income taxes and a ten percent penalty on the earnings portion of the cash they later withdraw.  Compared to 401(k)s and IRAs, the typical 529 also has a far shorter time line for returns. “If someone’s going to do a 529 plan, it needs to happen the day after the baby gets its name, but few people think that far in advance,” said Tove. Still, a 529 might be a good choice for couples with several kids, and who are (relatively) certain they’ll use all of those funds for college.

Finally, Tove and Meyers both view a home equity line of credit as a better option than a 401(k) withdrawal, though it’s still a last resort. The best bet is to save as early and consistently as possible in an investment vehicle vehicle in line with a client’s risk preferences, income and time line.

Of course, not everyone plans so far ahead. In cases in which parents haven’t saved enough, can’t pay as they go and have (wisely) decided against retirement plan liquidation, the best option is often to compromise on school choice. “People say college isn’t about the money, but it’s always about the money,” said Meyers. “Expensive private schools have their specialties, and if you don’t get that specialized degree, it’s not worth it at all.” By attending community or state colleges for their first two years, students can still receive a high-quality education while putting themselves in better positions to determine the costs and debts appropriate to their future careers. For clients who lack the means to pay out-of-pocket, college is ultimately a business decision.