The Parent Trap: College vs. Retirement

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The Parent Trap: College vs. Retirement
by Rande Spiegelman, CPA, CFP®, Vice President of Financial Planning, Schwab Center for Financial Research
July 2, 2007

As parents, we may have different attitudes and motivations, and experience different constraints and conflicting priorities when it comes to saving and investing for our long-term financial future. For many of us, however, the tension is nowhere greater than between two of life’s biggest financial goals—sending the kids to college vs. funding our own secure retirement.

Illustrating the point, a survey commissioned by Schwab found that while nine out of 10 parents believe a college education is essential to their children's future success, the soaring costs of college leave many doubting whether they’ll have adequate funds to cover the expense. At the same time, most parents ranked other financial priorities ahead of saving for college. Saving for a home purchase or home improvement was parents' first priority, followed by saving for retirement and emergencies. Actually, saving for college ranked fourth out of six options, beating out saving for a vacation and buying a new car.

Maybe it was easier 30 years ago, when more people had kids in their 20s and retirement spending and college spending were far more separated chronologically. Today, it seems, parents tend to put off having children until later in life—even into their 40s. This means they’ll be writing tuition checks at a time when retirement isn’t that far off. Add to this the soaring costs of college and the fact that in the “good old days” more folks could at least rely on a company pension to take care of most of their retirement spending, and it’s not hard to see how the responsibility for self-funding both goals simultaneously can seem overwhelming.

You might be tempted to cut back on the money you invest for retirement to save for the earlier goal of your kids’ college. But you should explore other options first. One approach might be to set your target on two-thirds or one-half of the projected costs of college and offer your kids a “matching grant” of $2 or $1 for every $1 they come up with. There are any number of ways your students can come up with their share: study hard and get good grades now to qualify for scholarships and financial aid, work part-time or take out (and be responsible for paying back) student loans.

Asking a college student to work and/or take out loans may not seem attractive now (especially for the student). Ultimately, however, you aren’t doing your children any favors if you put them through school only to become financially dependent on them down the road. After all, while financial aid is available for college, you'll have a hard time getting loans or scholarships to fund your retirement later on. And you may prefer to have your child work part-time between the ages of 18 and 22 rather than working part-time yourself during retirement to make ends meet.

Ideally, you don’t want to sacrifice one goal for the other. Try to balance the two so you don’t shortchange your future or your children’s. Here are some additional ideas to help you achieve your goals for retirement and your children’s college education:

Take the sting out of college costs and save more for retirement

Run the numbers to see which universities your family can afford. Compare the costs of attending public vs. private institutions and consider the possibilities for financial aid. The College Board is a good place to get information on college costs and how to pay for them.
Save money by sending your child to junior college for one or two years, after which he or she can transfer to a four-year institution. If you live near a good university, you might save on room and board by having your child live at home and commute to school.
Help your student get his or her grade point average high enough to be eligible for more scholarships and financial aid.
Spend less and save more (an unpopular but effective choice).
Work more years before you retire.

If your child isn’t eligible for grants or scholarships, he or she can still apply for student loans at low interest rates. Interest paid on a student loan is tax-deductible—up to $2,500 per year—depending on income level. You may be eligible for other tax breaks, too, such as the Hope or Lifetime Learning credits. For more, see IRS Publication 970: Tax Benefits for Education.

Consider a whole-portfolio approach to investing
A whole-portfolio approach takes into account all your taxable and tax-advantaged investment accounts. You can always earmark certain portions of your portfolio for certain things. But putting it all together in one portfolio provides a big-picture view of your overall asset allocation. That way you can manage the total risk you’re taking on at any given time.

Incorporate your various goals—education and retirement, for example—into the big picture as you plan for future spending needs. You may find the pie is big enough for both, or that you need to adjust one goal or another.

Make the most of tax-advantaged investment accounts
For retirement, tax-advantaged accounts include those offered by employers—401(k), 403(b) and 457 plans, for example—as well as traditional IRAs and Roth IRAs.

Tax-advantaged college accounts include:

529 college savings plans. These plans are a popular choice because they offer the account owner control and flexibility, combined with special income tax and estate benefits. For more, see "Saving for College: 529 College Savings Plans."
Coverdell Education Savings Accounts. Formerly called Education IRAs, a Coverdell ESA allows you to put $2,000 away each year per child (if eligible), and you can usually invest the money however you like. What’s more, distributions are tax-free when used for qualified elementary and secondary education, as well as qualified college education expenses. For more, see "Saving for College: Coverdell Education Savings Accounts."
Custodial accounts. Funds in a custodial account must be used for the benefit of the minor child. When those children reach adulthood (usually age 18), it’s their money and they can spend it however they like, which may not be the same as what you would choose for them. For more, see "Saving for College: Custodial Accounts."

Keep in mind that 529 plans and ESAs are not considered assets of the child so are more financial-aid friendly (standard formulas count 20% of the child’s assets but only 5.6% of the parents’ assets). Custodial accounts are considered assets of the child.

Be a disciplined investor
Too much optimism in the wake of a bull market can prove costly. But too much pessimism in the wake of a downturn can also cause you to miss out when the market rebounds. It’s better to maintain an even keel through all kinds of markets—and that requires discipline.

That’s why it's so important to quantify your various goals—including college and retirement—and figure out how much money you can put toward each. Then, establish a sound savings and investment plan you can follow over the long haul no matter what the markets throw your way in the short term.

Reasonable estimates of how much you may be able to earn on your investments can help you create a more realistic plan. For more, see "What Are the Long-Term Market Prospects for Stocks and Bonds?" And don’t be reluctant to get some help if you need it.

Important Disclosures

This information is not intended to be a substitute for specific individualized tax, legal or investment planning advice. Where specific advice is necessary or appropriate, Schwab recommends consultation with a qualified tax advisor, CPA or financial planner.

The information presented does not consider your particular investment objectives or financial situation and does not make personalized recommendations. This information should not be construed as an offer to sell or a solicitation of an offer to buy any security. The investment strategies and the securities shown may not be suitable for you. Individuals should contact their advisors to help answer questions about specific situations or needs prior to taking any action based upon this information.

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