Lynchburg Living

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By Susan S. Davidson, CPA

With the rising costs of college education and uncertainty about the financial future, it is easy to see why many parents are confused as to which goal they should place as the highest priority—saving for their child’s college education or saving for their own retirement. Simply put, “You can always borrow money for college, but not for retirement,” suggests Richard Nash of USAA’s Financial Planning Services.

“For most people, retirement is the biggest expense they will ever have to fund. Because of this, we give funding retirement priority over college, a second home, and other goals,” he further explained.

Most parents, however, feel selfish placing priority on their own financial future. As a result, they decide to put off saving for retirement so that they can save aggressively for their child’s higher education. As noble as this gesture seems, keep in mind that there are no scholarships, grants or government loans offered to support individuals upon leaving the workforce. Also, take into consideration that by setting aside retirement funds now, you will ultimately lessen the likelihood that you will have to rely on your children to supply your future financial needs. With this in mind, it is possible for parents to provide for their retirement as well as for their children’s education and ultimately achieve the best of both worlds.

Tax-Deferred Retirement Plans

If saving for college and retirement simultaneously is an overwhelming thought, consider depositing all of the funds into a tax-deductible retirement savings plan. This approach has several benefits. First of all, every dollar that is deposited into a tax-deferred retirement plan reduces your current taxable income. You will not be taxed on those funds until you withdraw them from the account. Secondly, while taxpayers typically have to pay a 10 percent penalty for the early withdrawal of retirement funds, the IRS waives this penalty for “tuition and related educational fees and expenses.” So, if you need to withdraw funds from your retirement account to fund your child’s college education, you may do so penalty-free. Finally, retirement account assets are not considered in financial aid calculations. In other words, you may increase your chances of qualifying for financial aid if your college savings are in a tax-deferred retirement account as opposed to a regular bank savings account.

Considerations for Grandparents

According to a 1999 survey conducted by Fidelity Investments, “nearly two-thirds of grandparents indicated a willingness to contribute to their grandchildren’s college savings accounts.” Not only do these contributions afford grandparents the opportunity to play a vital role in advancing their grandchild’s education, but they are ultimately reducing the amount of their assets that will be exposed to the estate tax. The most popular college investment choice made by grandparents is the Section 529 College Savings Plan. While these plans are managed by the state in which the investment is made, the funds can be used at colleges and universities across the country. Earnings on Section 529 Plans are tax-deferred and distributions are tax-free as long as they are used for qualifying college education expenses.

Another popular option is the Coverdell Education Savings Account (Coverdell ESA). Like the Section 529 Plan, earnings from the Coverdell ESA are tax-deferred and qualified distributions are tax-free. Unlike Section 529 Plans, Coverdell ESA funds can also be used for primary and secondary education in addition to college education. However, there are limitations on the annual amount that can be contributed to a Coverdell ESA. Currently, the IRS allows annual contributions of $2,000 per child. Your financial advisor should be able to direct you to the investment option that will best fit your financial situation.

Financing Your Child’s Education

While there is no reason why parents should expect to fund their child’s education in its entirety, there is also no reason to expect a child to start their post-collegiate career saddled with 20 years of payments on student loans. Sally Herigstad of MSN Money suggests that, “Helping your kids through college is wonderful and demonstrates that you value their education. Give enough to help, though, not enough to lessen their investment in the outcome.” By expecting your child to contribute to the financing of his education, he or she may be more willing to consider less-expensive educational alternatives. For instance, just because a university charges twice the tuition of another does not mean that your child will get twice the education. Many students are choosing to attend their local community college to get core classes under their belts before transferring to the college of their choice. Upon transferring, in two years they will have diplomas from the same school as those who started there, for considerably less money!

While it is certainly advisable to start saving early for college, it is during the early years of a child’s life that many parents feel the most financial strain. From medical expenses to braces, clothing and entertainment, as well as the cost for sports activities, it is easy to see how difficult it is for parents of young children to have additional income to set aside for college, much less retirement! As Elaine King of the Financial Planning Association stated so well, “Clearly, while you should not compromise funding retirement for the sake of your children’s education, you can still carefully structure a college savings plan aligned with your retirement objectives, and ultimately attain the best of both worlds.”