Spoiler alert: It’s not even close. You should save for retirement first.
However – and this is a BIG however – you can do both. Setting up a college savings account alongside your retirement planning will benefit the whole family. You will give your child a great start toward college while you concentrate on building your nest egg for retirement.
Read on to find out why and how.
Save for Your Retirement First
It’s that simple.
Pensions are a thing of the past. Social Security benefits may provide supplemental income but will unlikely provide enough income to maintain the retirement lifestyle you envision. So, having a retirement savings plan is now necessary to make your Golden Years as comfortable as possible.
Starting to build your retirement nest egg as early as possible will help ensure that you wisely use the many years of potential earnings before your retirement. Today retirement may feel like eons away but ask anyone in their 60s how quickly the years pass.
Some tips to maximize your retirement savings:
- Enroll in your employer’s retirement savings plan such as a traditional 401(k) or a Roth 401(k).
- Take advantage of matching programs your employer offers. Many employers match your contribution to your 401(k) – with caps based on a certain percentage of your salary. Their match is powerful: a 100% return on your investment.
- Utilize auto-enrollment programs to establish great savings habits.
- Consider an IRA or a Roth IRA. Individual Retirement Accounts are not sponsored by employers and have different rules and regulations than 401(k) Plans.
Know the pros and cons for each and select a plan (or plans) that work best for your situation. One universal piece of guidance for retirement, college, or any other savings plan: establish a regular habit of adding to that account as frequently as possible. Saving monthly may produce the best long-term result, but any disciplined savings plan (quarterly, semi-annually, annually) is better than no plan.
Why retirement saving should be priority #1
Here are four reasons to prioritize your retirement savings over your child’s college savings and not give in to the temptation to withdraw from your retirement account to pay for college:
- You can’t borrow for retirement.
If you use your retirement nest egg to fund college for one or more children, you could be left working well past your desired retirement date. Students have options to borrow for college. You don’t have that option for retirement.
- You may incur a penalty and/or pay taxes for early withdrawal on retirement savings.
Those not yet 59½ years old may incur a 10% early withdrawal penalty in addition to being required to pay taxes on the distribution. Consult with your tax advisor or retirement plan company to make sure you understand any penalties or taxes that may apply to withdrawing from your IRA or 401(k) for college costs.
- Withdrawing for college will likely occur at a critical juncture.
Over the past 15-20 years, you may have begun to establish a nice retirement nest egg. With another 15-20 years before you retire, you can now more accurately estimate how much you will have saved for retirement. With your peak earnings years beginning to wane and the retirement finish line coming into sight, this is the time to increase retirement savings, not erode them.
- You can’t control someone else’s college experience or when (or if) the money will be repaid.
Although it’s difficult to imagine for our children, not all students have successful college careers. Putting your retirement savings at risk or depleting your nest egg without any solid expectation of repayment could derail years of good savings and potentially endanger your retirement. While you cannot predict the future of your child’s academic success, you do know and understand your own future financial needs better than anyone else.
Having said this, saving for retirement and college does not have to be mutually exclusive. Both can be achieved.
Saving for retirement and saving for college are not mutually exclusive
Airlines instruct parents to don their oxygen masks before assisting children. The theory, of course, is that if a parent becomes incapacitated, they cannot help the children. Likewise, parents who are saving for retirement have donned their masks but also have an opportunity to help their children save for college.
You can set up a college savings plan with a nominal opening contribution. With an account in place:
- Friends and family can make gift contributions for birthdays and holidays.
- Even as you contribute toward your retirement, you may be able to make small adjustments to your monthly budget to direct just a little more savings toward college.
- As your child gets older, they can make contributions from allowances or job earnings as well.
How to Save for College
Just as there are many ways to save for retirement, there are several ways to save for college. Each family has unique factors such as income, spending habits, number of children, lifestyle, and accumulated wealth. There is no one “best way” to save for college for all families.
529 College Savings Plans have become a very popular way to save. You can find a plan with this easy-to-use tool offered by the National Association of State Treasurers. Many families have found that 529 College Savings Plans offer the features and benefits that fit their needs including:
- Low minimums to open an account:
Often as low as $10 or $25.
- Unlike taxable brokerage and savings accounts, taxes are not paid annually on earnings accumulating in 529 Savings Plans.
- No taxes are paid at the time of withdrawal if the money is used for Qualified Educational Expenses.
- Some states offer state tax benefits and key benefits like the exclusion of 529 assets from consideration for state financial aid determination.
- Annual contributions up to $15,000 for single filers and $30,000 for joint filers are considered completed gifts for federal gift tax purposes. A special accelerated gifting provision allows up to 5 years of gifting to be made in a single year allowing single filers to contribute up to $75,000 and joint filers up to $150,000 in a lump sum.
- Contributions to an account are generally removed from the account owner’s estate for federal estate tax purposes.
If a child does not attend college, parents can change the beneficiary of the 529 to themselves or another family member.
- No income restrictions:
Regardless of income, a parent or grandparent or anyone really may open 529 Saving Plans as the “account owner” for the benefit of a child, a.k.a. the beneficiary.
- Relatively high maximum contribution limits:
The total amount of contributions that can be made to an individual beneficiary’s account (a.k.a., maximum contribution limits) vary from program to program, but are often $250,000 or more.
- Multiple investment opportunities:
Most 529 plans offer a wide range of investment options including funds that automictically reallocate investments based on the age of your child or how many years it will be before the money is needed.
- The use of 529 savings has been expanded.
- Qualified Educational Expenses at the federal level (and often at the state level) include not only higher education related expenses, but also certified apprenticeship programs,
- Up to $10,000 per year for tuition at eligible primary and secondary schools,
- Up to $10,000 per beneficiary (or a sibling) to pay down a student loan
Here are six ways to help your children save for college while you continue to save for your retirement:
- Set up a college savings account for your children now.
It’s never too early or too late to start saving for college. This seemingly simple step is too often delayed resulting in missed savings opportunities.
- Use crowdfunding.
Encourage relatives and friends to contribute to the 529 Savings Account for birthdays, holidays, and special events. Most 529 Plans have e-gifting platforms, or you can use programs such as the GiftofCollege – a gift registry for college savings.
- Ask Grandparents to contribute a portion of the Required Minimum Distributions.
The IRS requires those with IRA, Simple IRA, SEP IRAs and several other retirement plans to begin taking distributions at age 70 ½ or age 72 if your 70th birthday is July 1, 2019, or later. These requirements do not apply to Roth IRAs.
- Contribute “loose change.”
Although your main saving focus is saving for retirement, you will occasionally have some additional money that could be contributed to your child’s 529 account. Loose change could include cashback from your credit cards.
- Empower your child:
Help your child develop their role as an active saver for college. During the early years, it’s expected parents and perhaps relatives will make the lion’s share of deposits in college savings accounts. Deposit a portion of a child’s allowance or earnings from doing jobs around the house into their 529 Account. Once the child begins working part-time, add a portion of their earnings to the college savings account to get involved. In addition to increasing savings, you are promoting financial literacy skills to help your child learn the value of money and saving.
What to do next
Parents can successfully save for retirement and college simultaneously. Prioritizing retirement savings, while providing a mechanism for college savings can result in growing both a retirement and college nest egg.
The keys for success:
- Start today
- Establish a consistent habit of savings
- Enlist others to assist with your college savings goals