For many parents, deciding how much to save for retirement versus what to set aside for a child’s education can be a difficult balancing act. We are often asked if it is best to save for retirement or fund college savings. We believe saving for your future should be a priority, particularly through maximizing the benefits of retirement plans.
Why Prioritize Retirement Savings?
Funding sources. Where will you get the money to pay for your retirement? For most retirees, social security and personal savings represent the main sources of income. Without placing a focus on saving throughout your adult life, you may jeopardize the security of your retirement.
Students, on the other hand, can obtain college funding from several widely available sources. If family resources (such as a college savings account) are not available, students can seek financial aid, federally guaranteed student loans, grants, and scholarships. These vehicles have unique benefits and tradeoffs, but they can be expected to provide accessible options for paying for college.
Cost variability. Educational expenses are much more variable than retirement costs. Although inflation drives up both types of expenses over the years, students have a wide range of pricing options. They can take advantage of the large cost differences between public versus private universities and in-state versus out-of-state institutions. Online degrees can also be considered.
Retirees will not have the same flexibility without making sacrifices to their desired lifestyle, especially regarding housing and leisure activities. Health care costs, which typically rise in the retirement years, are difficult to control. All in all, given the unpredictability of retirement expenses, you may face some challenging choices in the future if you do not have sufficient savings.
The reality. Once you leave the workforce, your financial options may be limited. In contrast, your family should be able to combine a variety of funding sources to pay for college. So, while you may relish the idea of fully funding a child’s education, doing so might not be the wise choice.
Balancing Savings Needs
Fortunately, the advantages of retirement plans and college savings plans make it possible to balance your financial priorities. Let’s look at some of the unique features of these plans.
Retirement plans. Putting the maximum possible into your retirement accounts is ideal, especially if your employer offers a matching contribution. That can add up to a substantial amount of extra income. In addition to the tax-deferral benefits, an IRA or 401(k) account can work well to complement your college savings goals in the following ways:
- As related to the Free Application for Federal Student Aid (FAFSA), retirement accounts are considered noncountable assets, so they do not affect a student’s aid eligibility.
With an IRA, early withdrawals can be made for qualified educational expenses. The standard 10 percent penalty does not apply, although these distributions will be taxed. (This feature does not apply to 401(k)s.)
College savings plans. A college savings plan is a great way to save and pay for college. What type is best? That depends on your situation, but 529 plans are popular for many reasons. Here are some of the many benefits:
- Earnings grow tax-deferred. Many 529 plans have large contribution limits compared with other college savings plans, so the tax advantages could be significant.
- Qualified education expense distributions are not subject to federal taxes. (Tuition, supplies, etc.…)
- Since 2019, qualified expenses include certain student loan repayments up to a lifetime limit of $10,000 for the 529 account beneficiary and for each of the beneficiary’s siblings.
Finally, you should be aware that if you withdraw 529 funds for anything other than qualified expenses, the distributions could be subject to tax on the account’s gains, as well as a 10 percent penalty.
Achieving the Right Balance
By putting money aside wisely, it is possible for parents to help provide for their children’s education without compromising a comfortable retirement lifestyle for themselves. For further guidance on this complex topic, please give us a call!
The fees, expenses, and features of 529 plans can vary from state to state. 529 plans involve investment risk, including the possible loss of funds. There is no guarantee that a college-funding goal will be met. In order to be federally tax-free, earnings must be used to pay for qualified higher education expenses. The earnings portion of a nonqualified withdrawal will be subject to ordinary income tax at the recipient’s marginal rate and subject to a 10-percent penalty. By investing in a plan outside your state of residence, you may lose any state tax benefits. 529 plans are subject to enrollment, maintenance, and administration/management fees and expenses.
This material has been provided for general informational purposes only and does not constitute either tax or legal advice. Although we go to great lengths to make sure our information is accurate and useful, we recommend you consult a tax preparer, professional tax advisor, or lawyer.
Bisdorf Palmer, LLC is located at 201 American Concourse, Ste 310, Fort Worth TX 76106 and can be reached at 682-224-4001. © 2020 Commonwealth Financial Network®