When I used to lead retirement seminars, I was surprised by how often a couple nearing retirement would tell me that they had a child in high school and they wanted to work toward saving for that child’s education. They would ask me: “Should we wait to focus on retirement savings until our child’s education is funded?” My answer was always, “It depends — let’s take a closer look at your situation.” Most often, after taking a look at the numbers, the answer was a resounding “no.” As the adage says, “Your child can borrow for their education, but you can’t borrow to pay for your retirement.”
I realize that likely sounds harsh — particularly to those who have recently paid off or are still working to pay off their own student loans — but it’s true. While working towards helping a child pay for their education is a very noble pursuit, it has to be done in concert with your other personal goals. And, as with most financial goals, the earlier you can get started, the easier it will be to achieve. Here are four key steps to take:
Identify Your Priorities: The best first step is to survey your overall financial goal landscape. How are you doing with your emergency savings? Do you have a short-term savings fund and a plan to make your long-term goals a reality? Do you have any high-interest debt (debt with an interest rate of 10% or more) you’re trying to get rid of? How are you doing with your retirement savings? Lastly, if you have your own student loan debt, do you have a plan in place to pay it off or will taking on this goal set you back? Don’t forget about any other personal goals you have as well. I realize this can feel really overwhelming, but taking the time to figure out which goals you are trying to reach, by when, and in what order of priority they fall is going to be immensely helpful in the long run. Unless you’ve got your budget, emergency savings, retirement savings, and debt repayment on lock, you may need to wait to pursue this particular goal.
Tip: It’s not unusual for people to ask about saving for their child’s education when their child is already in high school. While you can certainly scrape some money together at this point, often that’s too late in the game to make a big difference. Depending on your goals and the order of priority, this is a great goal to get started on early and chip away little by little.
Decide Your Limits: Start by getting to know the numbers. According to US News & World Report, for the 2020-2021 school year, the average tuition and fees for ranked colleges was about $35,000 for a private college, $21,000 for a public college out-of-state, and $10,000 for a public college in-state. Use a college cost calculator to help you estimate the total cost of college for your child — taking into account inflation. Once you know the numbers, you may decide to set a goal (like paying for a ⅓ of your child’s education costs) and work backwards to see how much you’ll need to contribute. Or, you may decide to start with what you can contribute (such as $100/month) and see how far that contribution will go using a college savings calculator.
Tip: Remember, as generous as it is to want to pay for your child’s entire college education, that won’t be reasonable for most parents. Don’t forget your order of priority as you set these goals.
Find the Right Savings Vehicle: Three of the most popular ways to stash away money for a child’s education are 529 plans, Coverdell education savings accounts, and Roth IRAs. Each comes with its own pros and cons. 529 plans tend to be the most popular and they come in two flavors: 529 savings plan (after-tax dollars set aside in an investment account to grow tax-free) and 529 prepaid tuition plans (“lock-in” tuition costs by paying in advance to a particular school or group of schools). While you can seek out a 529 savings plan from any state, generally the 529 savings plan from your own state may carry additional incentives like tax credits or matching funds. 529s are popular for a reason: the contribution limits are high (typically up to $300,000 in lifetime contributions), you can change beneficiaries, and it has little impact on financial aid awards since it is considered a parental asset. The only drawback is the account can only be used for educational expenses (unless you want to pay the tax and 10% penalty on asset growth). Coverdell education savings accounts (sometimes called “Coverdells” or “ESAs”) are similar to 529s in that qualified withdrawals are tax-free; however, they tend to come with more limitations on contributions, income levels, and beneficiary age. The process of changing beneficiaries is also a little less straightforward than 529s. One of the benefits of Coverdells is that they can be used to support your child’s education throughout their lifetime: K-12, college, and even grad school. A third popular option is a Roth IRA. Roths offer the most flexibility since they allow you to withdraw money for qualified education expenses without penalty. If your child doesn’t go to college or receives significant scholarship funding, the money can stay invested towards your retirement. However, the major drawback of the Roth IRA is that any money withdrawn shows as income, which may impact financial aid eligibility or awards.
Tip: Remember, all of the plans discussed above are invested in the stock market. In general, the stock market is best for pursuing long-term goals. As your child’s college start date approaches (generally 5 years out and closer), you may want to talk with an investment advisor or financial planner about how you might scale back your risk.
Collaborate with Your Child: Education is expensive — but the best lesson just might have to do with financial responsibility and values. Be upfront with your child about how much you plan to cover and what they might be responsible for. Encourage them to apply for scholarships and grants to help cover their portion of the cost. As your child looks at colleges, be attentive to the expense of each institution so they understand what type of debt they may need to take on.
Tip: Depending on the investment vehicle, it’s possible other people may be able to contribute toward your child’s education. Instead of (or in addition to) birthday or Christmas presents, you might encourage caring family and friends to contribute towards your child’s education.