Why You Should Prioritize Retirement Savings over College Savings
Young families with an eye to the future are faced with a daunting choice – to save earnestly for a secure retirement or to save for their children’s education. Can you do both? Certainly it is possible; however, with the cost of a college education and retirement (thanks to health care costs) rising faster than the rate of inflation, just targeting one of those goals with savings is no sure thing. And, with the increasing number of people reaching the retirement threshold unprepared and underfunded, financial planners today strongly advise their clients to focus on their retirement savings first. After all, a secure retirement rests squarely on your shoulders; while there are other funding sources that can contribute to your child’s education.
There are actually several good reasons why you shouldn’t save directly for college savings, instead, packing your retirement accounts as full as you can get them.
- The first was referenced above – unless you’re one of the lucky few who still have a guaranteed pension, if your retirement is to be, it will be up to thee. You only get one shot at accumulating enough capital to sustain a lifetime income that will meet your lifestyle needs.
- Secondly, qualified retirement plan assets aren’t included when determining your student’s eligibility for financial aid. You could have a million dollars in your 401k plan, but it won’t affect how much aid your student might receive. Depending on the type of aid and the formula used by the college, even high income earners can qualify for financial aid. The financial aid formulas are very complicated and beyond the scope of this article to explain; however, it is safe to say that assets accumulated in your child’s name, can be counted against his or her eligibility.
- Third, some qualified retirement accounts can be used as a source of college funding. IRAs can be tapped for education expenses; and, if you have a Roth IRA, the withdrawals can be tax free. 401k plans also have provisions for accessing funds for college expenses. While it’s not recommended that this be their primary purpose, if you do well enough in saving for retirement, you may be able to draw down some supplemental funds without impeding on your retirement savings need.
Many students can’t make it through college on financial aid alone and will need to be able to access funds saved for that purpose. If and when you have the means to start saving for both retirement and college, you should consider a 529 College Savings Plan. The tax incentives – tax free accumulation and tax free withdrawals for qualified expenses – make them very attractive. In addition, less than 6 percent of their value is counted towards the formulas for determining financial aid eligibility and amounts.
You Need a Strategy for Saving and Paying for College
For many families, the cost of a college education is beyond their financial capacity, unless they were to focus on college savings at the expense of their retirement savings; but that could be a costly mistake. Instead, families should develop an overall strategy for both saving for college and paying for college, which would include many of the college funding resources available (i.e. financial aid, grants, scholarships, loans, etc.) For the best possible outcome, parents shouldn’t wait beyond their child’s freshman year in high school to develop and implement their strategy. For that purpose, it might make sense to work with a college funding specialist who knows their way around the financial aid and scholarship landscape.
Contribution limits vary by state. Contributions to a Section 529 plan are subject to applicable limits under federal gift tax and generation skipping transfer tax provisions and may be subject, upon distribution, to federal income tax if the amounts are not used for higher educational expenses. Penalties, in accordance with IRS guidelines, may apply to distributions that are not attributable to higher educational expenses of the designated beneficiary, made on account of the death or disability of the beneficiary, or due to rollover.
State tax advantages vary from state to state and may depend on whether you are a resident of the state sponsoring the plan. Investment options vary greatly - from high-risk stock funds, to funds that contain a mix of stocks and bonds, to conservative investments that contain money market or short-term bond funds. Most plans offer age- or enrollment based investments that grow more conservatively over time, as the beneficiary gets closer to Using the proceeds to pay for college expenses. Many plans also offer static investments where assets are typically invested in a set allocation of one or more mutual funds.
As with other investments, there are generally fees and expenses associated with participation in Section 529 College Savings Plans. Fees and expenses vary greatly, even among plans offered within the same state. There is also the risk that plan investments may lose money or not perform well enough to cover college costs as anticipated.
Withdrawals may or may not be state income tax-free, depending on the participant's state of residence. Withdrawals of earnings for purposes of payingfor qualified higher educational expenses are federal income tax-free. This tax provision is available until December 31, 2010. After 2010, distributions may be taxed at the beneficiary's tax rate unless there is further legislation to extend or change the tax law. Withdrawals for non-qualified educational expenses are subject to a 10% federal tax penalty and are taxed as ordinary income.
You may obtain a copy of the Program Description that outlines the fees, expense and risks associated with this program by contacting my office. Read carefully before you invest or send money
This material was created to provide accurate and reliable information on the subjects covered. It is not intended to provide specific legal, tax or other professional advice. The services of an appropriate professional should be sought regarding your individual situation.
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