Lisa Ward for the Wall St. Journal writes: It's the fundamental financial conflict that many families face: saving for college vs. saving for retirement.The pressure is intense on both sides. College costs continue to outpace inflation, with the average price for four years of private college now at a terrifying $158,000. Meanwhile, the pressure to build a large nest egg for later life has grown due to longer retirements, dwindling pensions and uncertainty about Social Security and Medicare.
So how do financial experts recommend juggling these two savings goals? Here are some of their pointers.
Prioritize Retirement
Here's a piece of advice that's tough for many parents to swallow: It is more important to save for retirement than for college. It may sound selfish, even irresponsible. But it's true
"Unless your retirement plan is for your children to take care of you, retirement funding must come before education funding," says Rick Lowe, a senior financial adviser at the Ayco Co. unit of Goldman Sachs Group Inc.
The reason is simple: Saving is the primary way you can fund your retirement, especially if Social Security is unlikely to replace a significant portion of lost income and you aren't entitled to a big company pension.
College, though, can be funded many ways. For the 2012-13 school year, parents on average paid 27% of college tuition from income and savings, according to Sallie Mae. The rest came from grants and scholarships (30%), student loans (18%), student income and savings (11%), parent borrowing (9%), and relatives and friends (5%).
New Baby? Think College
Putting yourself first doesn't mean you don't worry about the kids at all. But it does mean you need to start worrying as early as possible. Because the sooner you start saving for college, the smaller the drain it will be on your budget, leaving you more money to fund your retirement.
Maria Bruno, an investment analyst at Vanguard Group, says parents should start saving when a child is born. According to Vanguard's online calculator for college costs, parents who save $300 a month from the time a child is born can expect to have about $120,000 put away when it's time for college. But if they start saving that same amount when the child turns 10, they don't just fall behind by the amount they didn't save all those years; they also miss out on all the money those savings would have earned. They end up with only about $50,000.
Minimize Taxes
Another way to minimize the drain from college savings, freeing up more money to put away for retirement, is to save on taxes. Financial advisers recommend using a state-sponsored 529 college-savings plan.
Thirty states give a tax deduction to residents who invest in a 529 run by that state, according to Morningstar Inc. Six others offer a tax benefit to residents who contribute to any 529.
In a 529, the money compounds free from all taxes and can be withdrawn tax-free to pay for qualifying college costs.
Other Options
One drawback of a 529: Earnings are subject to tax and a 10% penalty if they aren't used for education. Similarly, there is a 10% penalty in most cases if you take money early from a 401(k) for education—if your plan even allows such withdrawals, which many don't. So you may want to put at least some savings in investments that can be used for either college or retirement, to keep your options open.
One option is U.S. Treasury inflation-indexed savings bonds, known as I bonds. If an I bond is held for at least five years and then redeemed to pay for your kids' college expenses, the interest is free of federal taxes if annual income is below $72,850 for an individual or $109,250 for a couple. The tax is reduced if income is below $87,850 for an individual or $139,250 for a couple. If you hold the bonds for retirement, you pay taxes on the interest when they are redeemed.
Roth individual retirement accounts also offer flexibility. With a Roth, which is funded with after-tax dollars, contributions can be withdrawn without penalty after five years, notes Morningstar analyst Adam Zoll. If earnings are withdrawn before age 59½, they are taxed as ordinary income. But a 10% penalty on those earnings is waived if the money is used for college. With a traditional IRA, the early-withdrawal penalty is waived for education expenses, but all withdrawals are taxed as income.
Just remember that this approach isn't ideal. "Most people don't do a good job saving for retirement, so diverting money from long-term retirement goals is a dangerous proposition," says Jay LaMalfa, a partner and financial adviser at Macro Consulting Group in Parsippany, N.J.
0 comments:
Post a Comment