A thirty-something couple was referred to us with a concern that we often see in this age bracket. Their children were growing up fast and the thought of saving for college was becoming a stressor. They read the articles that say retirement should be a priority but felt compelled to put their children ahead of themselves as most parents do. Darn parental instincts.
Most parents understand the time spent in college is much shorter than the time spent in retirement, well unless you are my cousin who is approaching 40 and still a college sophomore. We are pulling for you Bobby! Most folks also know they can borrow for college and not their retirement. These are pretty standard arguments for putting retirement first, but let’s dive a bit deeper.
More and more schools are now requiring parents to fill out the College Board’s profile form as well as the Free Application for Federal Student Aid form, known as FAFSA. These forms are plugged into the computer and ever-changing formulas are used to determine the family’s ability to pay for college. Money invested into the parents’ 401(k)s, IRAs and other retirement accounts aren’t counted as assets available to pay college bills. The flip side is when the formulas calculate the ability to pay for tuition out of income they ignore your need to save for retirement.
But there’s a catch; there’s always a catch! Making significant contributions to your pre-tax retirement accounts at the time of applying for aid and during the college years can actually lower the aid you receive. Crazy I know, but these retirement contributions decrease the federal income tax you pay, which, as the colleges figure it, increases the amount left for them to take.
So how should you play it? One strategy we like is to pile as much as you can into your retirement accounts until the children are of college age. During the college years direct excess income towards tuition and after the school years go back to funding retirement. It strikes a balance while not ignoring one financial goal for the other.
But this strategy is by no means a one size fits all and a number of variables come into play. For instance, if your income is high enough where financial aid is unlikely or you are already maxing out the contributions limits for 401ks and IRAs, college savings may be on the front burner.
As always the best strategy is to explore this in detail and draft a plan that weighs the options. Your financial adviser should provide with you a detailed written plan that takes into consideration all of your goals, if not, find one that will.
Shawn Miller is a fee-only Financial Adviser at Sovereign Financial Services based in Bel Air, MD. Where he provides advice to individual, businesses, and endowments. You can reach Shawn at 410.575.3120.