Kid’s College or My Retirement?
You’re a parent of a young child. You hope they’ll go to college one day. You hope to retire someday. You know college is going to cost a boat load. You also know you have to save for retirement because you actually want to retire someday. How do you juggle these two huge savings goals and which should come first?
“Should I start saving for my kid’s college or put more towards retirement?
“I know I should start saving for kid’s college… we all know that’s not getting any cheaper!”
“I’ve started saving for retirement, should I stop contributing and focus on my kid’s college savings?”
These are all GREAT questions that I’m asked often. Heck, I’m in the same boat personally! So, PAY ATTENTION and bookmark this one. Reference back to it often as you may want to refresh your memory when you start straying one way or another.
Parents are faced with tons of choices! Many of the parents I’ve encountered fall into one of three categories:
- The Young Parent – Young Kids: Parents with young kids who are just getting into their “career” job. They are asking, should I save for retirement OR my kid’s college. Cash flow is tighter for these people, as they are younger, and they are just getting started with all of this.
- The Career Parents – Young Kids: Parents with young children who are already saving for retirement, and are asking “should I increase retirement savings, or keep it the same (or even reduce) to start saving for my kids’ college?” These parents have solid jobs, with solid incomes, and experience raises from time to time. They have sufficient cash flow to save.
- The Seasoned Career Parents – Kids: Seasoned parents well established in their careers with solid retirement savings, and are asking “Should I start saving for my kid’s college, and how much?” Very solid income and well established in their career. They maybe had children later in life, and are now faced with a unique circumstance.
What follows is what I hope to be a guide for you to think about your own situation. I offer scenarios to think about, steps to take, a sequence to follow, to come to your own conclusions about what you can and do in your own personal finance journey. My hope is that you’ll be able to answer the questions above, for yourself. Every situation is different and you’ll find that my guide below, ebbs and flows with different scenarios. Please use it as a guide.
Progress over Perfection
Also, please remember that we are not looking for perfection here. Of course I want you to live your life to its fullest, full of financial gusto! But remember, that it’s a journey, not a destination.
Let’s get into it.
I’m first going to paint a picture of the college tuition landscape as well as the retirement landscape to simply provide context (and perhaps an ice-cold shower of reality). Then, I will provide a first, second, and third step process for you to complete and actually be intentional about your financial life.
First, ‘the ice-cold shower’
Here are a few things that we know, college tuition… it’s EXPENSIVE! On average, college tuition is rising at a 6% per year clip… over 2 ½ times the inflation rate and much more than wages. Said another way, since 1982 family wages have increased by 147%… college tuition has increased 500%.1
The average 4-year in-state public school (tuition, books, and room & board) = $19,548 per year
The average 4-year private school (tuition, books, and room & board) = $43,921 per year
The average 2-year public school (tuition & books only) = $3,435 per year 2
Here’s the crazy part…
If college tuition continues to rise at a similar pace to what it has (6%), in 18 years the costs for college will be:
The average 4-year in-state public school tuition will = $55,796 per year
The average 4-year private school tuition will = $125,365 per year
The average 2-year public school tuition will = $9,804 per year
The Retirement Landscape
– The average 50 year old has $42,797 saved.
– The average net worth (assets minus debts) of a 55-64 year old is $45,447.
– 45% of Americans have saved nothing for retirement, including 40% of Baby Boomers.
– 38% don’t actively save for retirement at all.
– 20% of Americans tap into their 401(k) assets early, either through a loan or withdrawal.
– 80% of Americans between the ages of 30 and 54 believe they will not have enough saved for retirement. 3
Now that we have seen a sneak peek into the college tuition and retirement landscape, let’s look a little further into retirement and answer a question I get often:
How much can I take from my investment savings in retirement?
4% per year. This number tends to change, year to year, and there’s research that points to the fact that it should change each year, based on your personal situation and market fluctuations. But on average, 4% per year. So, if you have $1,000,000 saved, that’s $40,000 per year. If you have $250,000, that’s $10,000 per year (or $833/month). You can read research around this 4% number HERE.
So is saving for retirement important? Without a doubt. I share these statistics above to help you think about your own situation. Do these numbers sound reasonable to you? Does $10,000/year or $833 per month, before tax, sound reasonable to you based on you needing to save $250,000 by retirement? Stop what you’re doing and think about these numbers. You’ll want to come back to them.
Now that you understand that BOTH, retirement savings and college costs are amazingly important and neither is getting any cheaper, let’s move on!
Here we go: A guide to help you prioritize and plan for Your Retirement vs. Your Kid’s College Savings.
Step 1: Prioritize.
I was recently quoted in US News saying, “College students can take out a loan for retirement, but parents can’t take out a loan for retirement.” Read more about this topic by clicking HERE.
So, you need to give actual thought to how you feel about saving for college vs. saving for retirement.
Do you feel like you want to do both? Retirement AND College?
Do you feel “pressure” to save for your child’s education?
When push comes to shove, do you feel like your own retirement is more important to focus on?
Are you currently on track for your retirement goals?
Do you want to make sure you pay for as much of your child’s college as possible, because above all else, that’s what is most important to you?
Are you okay saving for a portion of your child’s education or do you want to pay for all of it?
Do you want to do for your kids, what your parents did for you?
These are all questions you need to ask yourself. Actually think about them and try to gauge your feelings. Try to prioritize ‘My Retirement vs. Kid’s College’ by just giving intentional thought to each topic. Internally weigh each option. My guess is that you’ve never really given this dedicated thought, so this exercise should help. I know it did for me.
Step 2: Make that first decision
So you’ve prioritized and have at least given thought to what’s important to you. If you weren’t able to actually determine one to be more important than the other, that’s okay!
Here’s what I’d say to that: Just Start with Retirement
Remember my quote: “… can’t take out a loan for retirement…?”
Also, this isn’t the end game. By starting with retirement you are not automatically saying, “Forget about college savings.” You’re just being responsible and starting somewhere.
So, begin with retirement. If you can’t make a decision, kid’s college or retirement… take my advice, start with retirement. Got it?
Do this by participating in your employer’s 401(k) plan (or via a Roth/Traditional IRA). If a 401(k) plan, fund it up to the employer matching point, to at least receive their free money (match). For more on 401(k) matches, and this particular step, click HERE. So, contribute a percentage of your pay to your 401(k). Make sure put enough in to get your employer match. You obviously need to monitor your cash flow to make sure that by funding up to the matching point (or to some reasonable amount if your employer doesn’t match OR if their match is very low). Start with something like 6% of your pay. Start by saving 6% of each paycheck to your 401(k) plan. After you do this and you presumably have some cash left at the end of the month… move on to the next step.
Step 3: Okay, now make the ‘Second Decision: More to Retirement or College Savings?
Option A: This scenario is usually found in group #1 from above, the Young Parents – Young Kids. (It’s also common with someone starting over in a career):
First: contribute to your retirement ONLY up to the match point or to some smaller amount to an IRA (or to some reasonable amount into the 401(k) ie: 6%).
—> Then: if there’s money left over, decide: more to retirement or college? Move on to the following ‘Work Backward’ Steps to determine how much to contribute and to weigh the costs.
Option B: This usually goes to Group #2: The Career Parents – Young Kids and also to Group #3: The Seasoned Career Parents – Kids:
First: contribute past the 401(k) match point. Put more than the minimum to get an employer match into 401(k) or IRA. Consider putting 10% of your paycheck to your 401(k).
—> Then: if there’s money left over, decide: more to retirement or college? Move on to the following ‘Work Backward’ Steps to determine how much to contribute and to weight the costs. Consider using incremental raises to further fund BOTH (more to retirement & some to college)(more on that later). Consider other retirement savings accounts as well (Roth/Traditional IRAs).
Option C: max out your 401(k) = $18,000/year (for 2016)
—> Then: If there’s money left over, start a college savings account if you’ve identified it as a priority.
So, let’s eliminate Option C from further discussion for this post. It’s fairly clear: if you have enough money left over after maxing out your 401(k) AND you want to save for your kid’s college, take the extra money and fund a college savings account to an amount you determine. No problem.
I should note here, that there are other retirement accounts that you can contribute to while contributing to or maxing out your 401(k). So don’t think that it’s 401(k) and then retirement savings is done. For purposes of this post, we’ll circle back to this option after you’ve maxed the 401(k), fully funded your college account, and still have cash flow to save additionally to retirement (using a Roth/Traditional IRA). For now, let’s discuss Option A & Option B further.
Most people that I encounter are asking ‘My Retirement or Kid’s College?’, because they are in one of the first two groups. They are “normal” people with good-to-excellent incomes, but have to make choices around where the “extra” goes.
First: Don’t reduce or lower your retirement savings to start saving for college. If you’re finding yourself considering lowering your retirement savings to begin saving for college, please don’t! Unless of course, you have clearly placed paying for college for your child at the very highest priority (above your own retirement). If paying for college “Takes the Cake” on your priorities, then perhaps it’s okay. Just know the cost and think long and hard about it. I don’t generally recommend that, but personal finance is personal and there aren’t formulas to put people in.
To help you make a better decision, around Option A or Option B, here’s the next question:
What to do with extra cash, after I contribute to my 401(k) or IRA up to a very healthy number?
By completing the following two tasks, you will be able to better understand your options and answer this question above. Knowledge is power! Informed decisions require you to be informed. You’ll be able to make much better decisions, once you figure out what college will cost and what it will take in monthly savings. The same goes for retirement. It’s important to know how much you need to save per month to have a certain lifestyle in retirement.
Work Backwards On Your Tuition Number
What I mean by that is to first think about college tuition. How much of your kid’s school do you want to pay for? Figure out what that number is, then work backwards to figure out how much you need to contribute monthly to have a shot at accumulating that amount.
Perhaps you want your kid to go to a specific school, or perhaps you are only willing to save a portion towards a specific school, then determine that amount. As mentioned above, the average in-state public school cost is about $20,000/year, all in. That $20,000 number, or a specific school tuition number, or a portion of that tuition that you’d like to pay for is then ‘Your Number.’ It’s the number that you need to start saving towards.
For example: $200/month to an account, earning an 8% rate of return, over 17 years, = approx. $86,000. Put another way, that amount should pay for about 4 years of in-state public school.
But don’t forget about inflation. Remember the second set of tuition figures I listed at the beginning, showing school costs in 17 years with 6% inflation between now and then.
You can use this calculator to run the numbers on other scenarios.
What if you put in $500/month for that time frame? Or what if you earned a lower rate of return?
Then after you’ve run some numbers, determine what that number is that you’d like to have saved for college.
Use this tuition cost tool below, to get a handle on what tuition is at a particular school. Perhaps you really want your kid to go to your alma mater? Why not check the tuition there? Or perhaps you hope they go to a specific private school? Check their tuition and get a handle on how much you want to save.
Here is a link to check the tuition cost at any particular school:
Work backwards and determine how much you need to contribute per month to make that happen.
Work Backwards Your Retirement Number
Okay, this one is a little more “out there;” literally. We’re probably talking 20-40 years away. But remember, if you’re hoping to have some type of retirement, it’s going to require a bucket of money that you’re going to need to tap into to live on. This will supplement your Social Security income and if you’re so lucky, any pensions you may have.
To work backwards on retirement, first you will have to do the same exercise that you did for tuition, for retirement. You need to determine “Your Number.” To do that, first determine what your income sources are in retirement, and then try (JUST TRY) to determine how much you’ll need in retirement.
For example: let’s say you plan on being employed for 35 years and you currently make approximately $80,000/year. At that income, and if you’re paying into Social Security, you can probably plan on anywhere from $25,000 – $70,000 per year of Social Security payments. This range factors in an amount in today’s dollars and an estimate of future, or inflated dollars. This is a fairly conservative estimate and that’s intentional. Whether or not Social Security will even be around in 30 years is beyond the scope of this conversation… 🙂 Let’s also assume that you are married (or were) and you have access to a spousal Social Security benefit. To be conservative, let’s assume it is half of what’s listed above.
Let’s say you think you can live on a similar income to what you have now ($80,000 in today’s dollars). But you’ll need to account for inflation. $80,000 today might be about $150,000 in 35 years. So that’s your first number. That’s your income/year number.
You’ll need enough fixed income and liquid investment savings to provide you a $150,000 before tax income. To determine how much actual investment savings you’ll need, take your income need amount ($150,000) minus Social Security (let’s use $40,000 for your SS and $20,000 for spouse’s social security) which equals $90,000. Assuming no other income sources, you’ll need enough investment savings to produce $90,000 (before tax) per year of income.
Do you remember how much you can take from your investments for retirement?
Remember the research indicated 4% as a safe withdrawal amount? This means that with a few assumptions, you can take 4% of your investment savings per year, without running a ‘significant’ chance of running out of money, and assuming these assets are invested well (most in equities, some in bonds).
So, based on being able to take 4% from your investment savings when you’re retired, you’ll need $2,250,000 of retirement investment savings to produce $90,000 per year of retirement income. (4% X $2,250,000 = $90,000) This assumes that the money is invested in globally diversified mutual funds at a low cost and professionally managed around a 60/40 (stock/bond) ratio. This assumes that you are getting some reasonable rate of return over a long period of time.
That was a lot of math… I know… But it’s so worth it.
Now the working backward part.
If your saving for 35 years, and earning an 8% rate of return (this assumes you have a fairly aggressive portfolio ie: 70/30 – 80/20 stock-to-bond ratio), and you need to accumulate $2,250,000, you’ll need to save $980/month.
Now that you’ve determined how much you’d need to save per month, to accomplish your goal of retiring with whatever amount it is that you need, how do you feel? Don’t freak out if you aren’t even close to where you should be. Remember, progress over perfection!
Can you save that amount per month? If you’re still a little freaked out… DON’T BE! Trust me, taking positive baby steps now, is so much better than waiting. Having some amount of time on your hands is THE most valuable asset.
What’s the Cost?
Another thought that I’d encourage you to pay attention to, is “What’s the cost?” In my occupation we talk about an “Opportunity Cost.” What are you giving up by doing something else? It’s important to think about these money opportunity costs, because money is real. You don’t need to fret about them, simply be aware of them.
If you’re a parent saving for your own retirement, and you’re considering reducing your retirement savings to begin saving for college, you need to be aware of that “cost.”
For example, if you can only afford to save $200/month to your own retirement, but you find it personally important to save for your child’s education. You decide to take $100/month from your retirement and put it towards college savings. So now you are saving $100/month to retirement and $100/month to college.
$200/month to retirement, at 9% growth rate, over 30 years = $366,000
$100/month to retirement, at 9% growth rate, over 30 years = $183,000
$100/month to college account, at 9% growth rate, over 17 years = $47,000
This reduction in retirement savings, might mean working an extra 5-10 years… are you okay with that opportunity cost to potentially pay for a portion of your child’s education? If so, great! Just be aware of it. If you’re not okay with that, then simply consider the cost and make your decision.
The Increasing Income Parents – The Perfect Scenario
If you find yourself experiencing periodic increases in income, and you are already well on your way towards fully funding your retirement accounts, you may be in the “Sweet Spot.”
The Sweet Spot is when you experience continual and incremental pay raises. You have already started saving for your retirement via a 401(k) or Roth IRA and they are very well funded (upwards of 10% of your pay going to them or you’re maxing them out). You experience regular pay increases and you feel it’s important to begin saving for your child’s education.
A method that I’ve found works really well in this situation, is to incrementally save towards both goals, with each pay raise.
So for example, if you get a pay raise of $100/month, why not put $50 extra towards your 401(k) to get as close to that maxed-out point ($18,000/year for 2016), and put $50/month towards college savings? With this strategy, you are essentially hedging your bet. You’ve begun saving for college, and are “paying yourself first,” with increases to your retirement accounts.
I’ve found that this strategy has provided many people with a great way to feel good about their progress, and feel a sense of accomplishment towards their goals. It doesn’t need to be an “All or Nothing” thing.
“Remember, your child can take out a loan for college, but you can’t take a loan out for retirement.”
Focus on your retirement first. With any extra cash, consider your priorities… Answer the question: how highly do you value paying for a portion of your child’s education?
Here’s one piece of information that we haven’t discussed yet. It’s in regards to my quote above: “Students can borrow for college, you can’t borrow for retirement.” If you are a “normal American” and you don’t have an unlimited income, consider encouraging your child to work through college! I know, I know… they have so much going on and their so busy…. which is all probably true.
Let’s get real: college students have some extra time and may be able to find jobs that allow them to study during work. Every extra dollar earned, counts! Working while in college may not be convenient, or fun, but neither is graduating with mountains of debt.
Let’s together, begin to change how kids think about college. Are loans a necessary part of the college experience? Can kids be working more during college to help cover the cost of college? Perhaps your child’s employment during college can supplement what you’ve saved and loans may not even be necessary.
We obviously have a student loan crisis in our country and we need to start the conversation to change this. The important part here is having a plan, sticking to it, and adopting it fully.
What type of college account do I typically recommend?
Stay tuned for future blog posts specifically about the different types of college savings accounts. But I want to provide you with one piece of information before then:
I generally prefer 529 Plans for saving for a child’s college education. Again, stay tuned for another post where I’ll go through the details and outline the details and Pros & Cons of 529 Plans.
There you have it! I hope this has been a helpful guide to help you think about your own situation. Remember, each situation is very different. You owe it to yourself to actually spend time thinking about your situation and how you can maximize your individual savings goals.
Don’t get frustrated in your savings journey. Spend a little time prioritizing what’s important to you. Assess your cash flow situation and regularly review it. Your situation will change year-to- year. Make that first, initial decision (choose Retirement!). Then as cash flow improves, make that second decision: more to retirement or to college? Stick to your plan. Review it often. Consider using raises to fund your goals (doesn’t have to be “all or nothing”) and consider using a budget to keep yourself on track! It’s all about cash-flow and priorities.
When all is said and done, it’s your retirement & college savings journey. There are a million ways to do it. The key is finding the way that reflects your goals and priorities and that you feel great about your decision.
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