College Savings or Retirement: How to choose?

College Savings or Retirement

Written by Vid Ponnapalli, MS, CFP®, EA

Vid Ponnapalli is a Fee-Only financial advisor providing Customized Financial Planning, Investment Management, and Tax Services for Busy Professionals in New Jersey, New York City, and across the country.

July 26, 2018

When my wife and I were raising our three children, and busy with our careers, we often discussed where should our surplus money go first: towards our kids’ college savings or to fund our own retirement? Very conflicting Financial Goals indeed! Luckily, the decision was not that hard for us because we were able to afford both.

Now, after more than a decade, I only notice the debate has picked up more steam than it was for me. Parents of young children, often ask me the same question – we are unsure which is a more important financial goal – our own retirement or our children’s College education. What do you advise?

As you debate prioritizing these two conflicting financial goals, you’ll be flooded with a lot of emotion. Shouldn’t we be thinking of our children’s future first? Or an investment in us (ie saving for our own Retirement) is the best thing we can give to ourselves, and in the process, later to our children?

In fact, here is what I tell my clients: there is no right or wrong answer. It all depends on your unique circumstances, and priorities. That said, it is worthwhile to examine the arguments from both sides before making an informed decision. Let’s discuss:

Retirement Savings First

I know a lot of financial advisors that tell clients to prioritize their retirement savings over saving for their kids’ college education. I also heard from a few parents that they agree with this. Their rationale is two-fold:

1) Saving for retirement is a necessity whereas saving for college is a luxury

This camp argues, while Social Security provides some retirement income, that income alone is insufficient to cover for basic retirement expenses, such as food, shelter, clothing etc., In fact, this Social Security publication supports their argument and states “Social Security was never meant to be the only source of income for people when they retire” and goes on explaining why.

So, yes – if you are not saving at least up to the point that you cover for basic lifestyle during Retirement, saving for Retirement undoubtedly takes precedence over saving for your kids’ college education. After all, this does make sense intuitively!

2) Children can borrow for their college education, but no one lends money for retirement

But, what if you are saving enough for basic retirement necessities – but not enough to cover your own expected lifestyle during retirement years? i.e., to fulfill all those nice-to-have retirement financial goals – such as your vacation home, travel, or entertainment with family and friends? That is true – now your dilemma is magnified. And the decision is harder!

Needless to say, the “Retirement Savings First” camp argues saving for your own retirement is more important even in such a situation.

They claim, there are several ways for your child to pay for college. For example, your child could get scholarships or grants. Or your child could do part-time jobs. And your child can also choose a less expensive school. On the other hand, they argue, there is no free money or no one lends money to fulfill your retirement financial goals – you are on your own!

College Savings First

“College Savings First” camp comes generally from these beliefs: 1) Retirement is too far away while kids’ college education is more immediate, 2) Saving for College offers tax benefits, and 3) this is a way to guard your child against an insurmountable debt in future. Let’s break this down:

1) Retirement is too far away while kids’ college education is more immediate

If you are like me and your youngest gets out of college when you just crossed 50, perhaps this will be true. In other words, assuming you intend to retire at 65 or 70, you have at least another 15-20 years to catch up on your retirement savings. Perhaps, you can boost up your savings after your children are done with their college and yet save reasonably well for your retirement.

On the contrary, if you are like most current day generation X families, perhaps your children are born in your mid to late thirties. If that is the case, you will have little time to catch up on saving for retirement after your kid finishes college – unless you are prepared to work well into your seventies.

So, the key is not to get caught by the notion that you will have time to save for retirement. My recommendation is to take this belief with a pinch of salt – In other words, analyze your own unique situation, and see if you could afford to save for your kids’ education while not compromising on your retirement goals.

2) Saving for college offers tax benefits

There is, indeed, much truth in this belief. No denial about that. In fact, my wife and I saved a lot in taxes while setting aside money for our three children in 529 plans.

For example, if you are a taxpayer in one of the states that offer immediate tax benefits for college savings, not saving for college is essentially turning down free money. In my own situation, I was a New York taxpayer – and I chose to invest up to $10,000 per year in an NY 529 plan, and saved NY state taxes on that contribution each year.

Secondly, the money you put in a 529 plan for your child grows tax-free, and when you use the funds for qualified education expenses, the entire growth is tax-free. In fact, this benefit was further sweetened, thanks to the new law – Parents can now save in a 529 Plan and use the distributions tax-free to fund the private elementary or secondary school education of their children. Truly, a great incentive to save for your kids’ college education!

3) Saving for college avoids insurmountable debt in future for your child

This is true as well. Debt is a burden, at any age. And the burden is more burdensome when you are just starting out your career – when your paycheck is small and your financial dreams are many! Think of it this way – every dollar saved for college ahead of time will save you (or your child) multiple dollars in debt payments after graduation.

So, if you could help reduce debt burden when your child graduates, while at the same time saving enough to manage basic necessities during your Retirement, perhaps it is a good compromise.

These are conflicting Financial Goals and there is No Clear Answer

In spite of all the above discussion, there really is not a one-size fits all answer because there are just too many variables to consider. Besides, it depends on your unique financial goals and circumstances. That said, here are few things that could influence your final decision:

  • does your company match your Retirement (such as 401K) contributions?
  • Do both parents work?
  • Are there any state tax benefits to college savings contributions? and
  • Can you save for retirement and also save for college? ie., can you afford to do both?

So, what do you think? Hope this article gave you some food for thought. Give me a call so that we can list all your variables, create some scenarios and then build an informed – and personalized – financial plan. I look forward to helping you answer this question for you and your family. Good luck!

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