College Savings Versus Retirement Savings

Financial Professional Content "There's no such thing as a retirement loan." So goes the oft-repeated argument that saving for one's retirement takes precedence over saving for college. In fact, the common advice is to "max out" contributions to 401(k) plans and IRAs before even thinking about putting money towards a 529 college savings plan. Better to have your child take out student loans than risk being financially stressed in your own retirement years. But it's not quite that simple. Some parents will choose to fund their children's college accounts even when they are not making full use of 401(k) plans and IRAs, and for these parents that decision may be the right one. One reason is that they get the same tax break with 529 plans that they get with Roth IRAs: zero taxes. In fact, the after-tax return can be even better with the 529 plan if that parent lives in a state offering a state tax deduction for 529 contributions. This is assuming, of course, that all the requirements are met for tax-free distributions from 529 plans and Roth IRAs. Admittedly, the argument for 529 plans over Roth IRAs weakens considerably as the risk increases that the targeted child will not attend college. Distributed earnings from a 529 become subject to tax and penalty in those circumstances. But many parents are pretty darn sure that their kids will going to college. A second reason is lower expenses, particularly when comparing 529 plans to 401(k) plans. Take a look at the typical fee disclosure document that is now required of all 401(k) plans. You should have no trouble finding a number of different 529 plans with significantly lower expense ratios. Of course, a matching contribution to a 401(k) from an employer should not be missed. But voluntary contributions beyond the match are a different story. And finally, there is the recognition that for many parents college comes along before retirement. Although there are no retirement loans, there may be other options available, and perhaps time to make necessary adjustments. According to one of our online polls, most parents are willing to delay retirement for a couple of years if it would mean less college debt for their children. But suggest to a child that college be delayed for a couple of years? Good luck. Certainly, IRAs can be repurposed to pay college expenses, but doing so can severely impact financial aid eligibility as any distributions must be reported in full as "income" on the following year's FAFSA. Parents who find that they must tap their IRA or Roth IRA for college would very likely have been better off with a 529 plan. (Noted economist and Harvard Professor Robert Pozen recently wrote that the federal government should permit unused balances in a 529 plan to be rolled into a Roth IRA, an idea that I have advanced in the past, and one that makes all the sense in the world. With Pozen's urging, perhaps now Congress will do something about it.) The overall point here is that choosing the proper savings vehicle is not a slam-dunk decision, and the best approach is to carefully coordinate college planning with retirement planning. Many factors, objectives, and expectations need to be considered in the analysis, and financial planners provide great value to their clients by focusing on these twin objectives. Financial Professional Content "There's no such thing as a retirement loan." So goes the oft-repeated argument that saving for one's retirement takes precedence over saving for college. In fact, the common advice is to "max out" contributions to 401(k) plans and IRAs before even thinking about putting money towards a 529 college savings plan. Better to have your child take out student loans than risk being financially stressed in your own retirement years. But it's not quite that simple. Some parents will choose to fund their children's college accounts even when they are not making full use of 401(k) plans and IRAs, and for these parents that decision may be the right one. One reason is that they get the same tax break with 529 plans that they get with Roth IRAs: zero taxes. In fact, the after-tax return can be even better with the 529 plan if that parent lives in a state offering a state tax deduction for 529 contributions. This is assuming, of course, that all the requirements are met for tax-free distributions from 529 plans and Roth IRAs. Admittedly, the argument for 529 plans over Roth IRAs weakens considerably as the risk increases that the targeted child will not attend college. Distributed earnings from a 529 become subject to tax and penalty in those circumstances. But many parents are pretty darn sure that their kids will going to college. A second reason is lower expenses, particularly when comparing 529 plans to 401(k) plans. Take a look at the typical fee disclosure document that is now required of all 401(k) plans. You should have no trouble finding a number of different 529 plans with significantly lower expense ratios. Of course, a matching contribution to a 401(k) from an employer should not be missed. But voluntary contributions beyond the match are a different story. And finally, there is the recognition that for many parents college comes along before retirement. Although there are no retirement loans, there may be other options available, and perhaps time to make necessary adjustments. According to one of our online polls, most parents are willing to delay retirement for a couple of years if it would mean less college debt for their children. But suggest to a child that college be delayed for a couple of years? Good luck. Certainly, IRAs can be repurposed to pay college expenses, but doing so can severely impact financial aid eligibility as any distributions must be reported in full as "income" on the following year's FAFSA. Parents who find that they must tap their IRA or Roth IRA for college would very likely have been better off with a 529 plan. (Noted economist and Harvard Professor Robert Pozen recently wrote that the federal government should permit unused balances in a 529 plan to be rolled into a Roth IRA, an idea that I have advanced in the past, and one that makes all the sense in the world. With Pozen's urging, perhaps now Congress will do something about it.) The overall point here is that choosing the proper savings vehicle is not a slam-dunk decision, and the best approach is to carefully coordinate college planning with retirement planning. Many factors, objectives, and expectations need to be considered in the analysis, and financial planners provide great value to their clients by focusing on these twin objectives.