How to Balance College Costs With Retirement
It's getting closer to the time of year when high school seniors eagerly check their online college application status and watch the mailbox for the infamous small rejection letter envelope or the big acceptance package. For a lot of parents and families, paying for college poses a massive financial challenge, and often, a choice: Do we continue to put money away for our own retirement, or do we divert funds to assist a child with the expenses of college? As a father of three, paying for the rising cost of a college education is something I think about often. It's disconcerting that tuition costs continue to outpace increases in health care, energy and housing. That's why it's more important than ever before to start saving early for college.
1.) Start early and calculate how much you'll need. Saving early on in your child's life is one the best ways to prepare for the future costs of college. Much like saving for retirement, the sooner you begin putting money away, the better. It's also important to recognize that where you keep your college savings can also play a large role in preparing for the future. Simply keeping college or retirement money in a savings account isn't enough. It is imperative that this money works for you, and continues to grow, so that its value keeps pace with inflation, as well as the rising costs of tuition.
Most states have individual 529 plans, which have become one of the most common vehicles for college savings. By setting money aside early and making consistent contributions, you can minimize the stress of meeting college expenses. Don't forget to take into consideration the annual percentage of increase in tuition and related costs, so that you can better understand your expenses once your child are nears college age.
2.) Identify costs and make decisions that affect college tuition. You have control over several important decisions that can drastically increase or decrease the cost of your child's college education. Much like meeting with a financial advisor, having a discussion with your child can be a valuable exercise, when planning for future college expenses. This sounds obvious, but by finding the right school, you can possibly avoid additional expenses like moving, associated transfer fees, lost credit hours, which can delay graduation. Although there are other factors that go into choosing the right school, starting the discussion early will greatly assist you as you begin the planning process.
One of the biggest factors that can increase the cost of college is the decision to go to a college or university that's in-state or out of state. According to a recent survey titled the "Average Published Charges for Full-Time Undergraduates by Sector," for 2013 to 2014, collected by the College Board, the average tuition for a public four-year, in-state institution was $8,893, while public four-year, out-of-state tuition was $22,203. That's a $52,000 difference over four years. The average for a private four-year university was $30,094. As you can see by doing some research, the in-state, public option can offer significant savings.
3.) Know the pros and cons of cashing out a retirement account to pay for college. Parents want to give their children a significant head start in life, if possible, and for many that means paying for their children's education, even at the risk of delaying their own retirement.
There have always been alternative methods for financing higher education, but I would say that there are very few alternatives for financing your retirement.
Your 401(k) will generally allow you to borrow 50 percent of the account value, up to the limit of $50,000. There may be a fee and typically an interest rate applied to make this happen, so be aware of these expenses up front. Also, when the loan is used for education expenses, it must be repaid within five years, and any amount not repaid is considered a withdrawal, so taxes, fees and penalties can be enforced.
Your individual retirement account will allow you to withdraw money for qualified education expenses unlike a 401(k), and the IRA allows you to avoid the 10 percent early withdrawal penalty. However, you are still responsible for paying ordinary income tax due on any distributions from a traditional IRA. Keep in mind that this distribution will be added to your ordinary income, which could affect your child's ability to qualify for financial assistance programs. The opportunity cost, taxes and penalties and a lower contribution limit, are the biggest reasons for not touching your retirement nest egg when financing a college education.
I strongly suggest exploring alternative options for paying for college such as having your children secure student loans, and helping pay the loan interest. When someone is responsible for repaying a loan, he or she usually takes the education more seriously. Students should also consider taking on a part-time job during the year or the summer to help defray a certain amount of the expenses. If you are considering making a larger part of an inheritance available to pay for college, add specific language about what the money can and cannot be used for.
4.) Understand your state's 529 plans. 529 plans or "qualified tuition programs," offer a great a way to save for college, and depending on your state, can offer valuable state tax savings. A short explanation, using Virginia's 529 plan, provides a frame for reference, but every state, including the District of Columbia, sponsors at least one 529 plan. These plans are primarily offered in two ways: prepaid tuition plans and college savings plans.
It's important to know that most prepaid tuition plans are sponsored by state governments and have residency requirements, and those benefits may not cover expenses for private or out-of-state tuition. College savings plans, or my example, Virginia 529 inVEST, allows families to choose from a variety of investment portfolios. The account owner can decide how much and how often to make contributions.
College savings plan account owners have the ability to make contributions into two different portfolio options: "age-based evolving," or "not evolving." Age-based evolving simply means that the investment portfolio's allocation changes as the student nears his or her college entrance date. Non-evolving accounts work exactly as they sound. The portfolio doesn't change for the duration of the account's life, unless you personally make changes in the portfolio. You can make these changes once per calendar year without fees. Benefits from these accounts can be used for any "qualified" higher education expense including tuition, room and board, textbooks and more.
The beauty of 529 accounts is that they're tax-advantaged accounts. This means that earnings and growth is tax-deferred while invested and are then excluded from income taxes when withdrawn to pay for qualified higher education expenses. However, if you spend earnings from a 529 plan on expenses not relating to qualified higher education costs, then you will be subject to income tax, and can expect to pay an additional 10 percent federal tax penalty.
Kelly Campbell, certified financial planner and accredited investment fiduciary, is the founder of Campbell Wealth Management and a registered investment advisor in Alexandria, Va. Campbell is also the author of"Fire Your Broker," a controversial look at the broker industry written as an empathetic response to the trials and tribulations that many investors have faced as the stock market cratered and their advisors abandoned their responsibilities to help them weather the storm.
