SAVE FOR COLLEGE OR RETIREMENT? WHAT YOU’RE NOT TOLD

Paying for college has been the theme of this important series using a three-prong approach. First is saving for college using accounts like the 529. If you have seen any recent news on the topic, you likely have a fundamental understanding of how this account works. This step also uses other savings vehicles. The second prong is to shop for colleges that fit your needs financially, socially, and academically.

Today’s article addresses perhaps the biggest question that influences families that are college shopping: Do I fund my child’s education or my retirement? The extent to which a parent favors one answer over another drives the family’s ability to pay for college. The last step we will explore involves saving on the cost of college.

We will review the issue of funding college versus funding retirement, why it is important and the standard industry advice. Ironically, the standard falls short in helping families answer this question. Inherit problems will be highlighted with the standard advice. We will wrap up the article with examples that demonstrate why saving for retirement first may be a bad idea. As always, you should check with your team of professional advisors to see how any of the concepts, terms, or ideas apply to your situation.

Why is funding college versus retirement such an important question?

Middle-class families live on limited incomes. A middle-class family must decide what to do with these incoming dollars. Do they save or spend the funds? If they spend, what do they buy? On the flip side, for which goal does the family save? Even knowing which goal should take the top priority, the family must make decisions about which vehicle (stocks, bonds, CDs, etc.) and account (Roth, IRA, taxable, 401k, 529, etc.) to use.

Several studies on American savings and habits clearly explain the stress we experience in our financial lives. With goals that cost millions (like retirement) or $100,000 or more (like college), is it any surprise that we stress about finances? It isn’t that families plan to fail in meeting their goals; instead, they fail to plan. To meet our goals, we must face the pain of discipline now; otherwise, we will face the consequences later. With limited income and expensive goals, where does a family save extra dollars?

Standard industry advice

The financial services industry tells families to save for retirement first. After this goal is met, the family can save for college. The language most families hear is something along the lines of “You can’t borrow for retirement, but kids can borrow for college.” Let’s look at a few examples from popular financial resources.

The article from Howstuffworks.com titled “The Kids’ College Funds Can Wait. Save for Retirement First” makes several points about why parents should save for retirement first.

– As previously mentioned, there are no loans for retirement.

– Working later because you funded your child’s education isn’t a plan. Forces outside our control – like a job loss or disability – can spoil our plans.

– You may be doing a disservice to your children if they end up supporting an elderly parent. While you may have paid $100,000 for their education, you did not save the $300,000 or more required to take care of yourself. Your child may end up footing the bill.

– Roth IRAs are a reasonable vehicle for college and retirement savings.

Consider the points from a Vanguard blog post, “Save for Retirement and College.” Here, the author suggests that you prioritize retirement before any other goal. “First and foremost, pay your future self. Unlike college, you can’t take a loan for retirement.” Second place on the priority list should be paying down debt, followed by a rainy-day fund. Saving for college should take fourth place, according to this author.

Carrie Schwab-Pomerantz also chimes in on the subject in a post called “Saving for College: Understanding Your Options.” Here, Carrie answers a question from a mother who is wondering about saving for college for her three-year-old child. College costs and savings vehicle information is shared. Carrie states:

“As parents, it’s natural to want to put our children’s needs first. But you can use loans to pay for your child’s education if you have to. You can’t get a loan for retirement. So, as important as college is, our retirement should always come first. Think of it as another way of taking care of our children, by ensuring we’re financially independent once we’re no longer working.”

The last financial guru, Dave Ramsey, leads his followers in “Retirement of College Funding: Which Comes First?” by asking “What is more important—my own security at retirement or my child’s education and future? There’s a lot of emotion wrapped up in that question, which makes it easy to come to the wrong conclusion.” Simply put, in his “Baby Steps,” Dave prioritizes retirement over college for a reason. “You’ll depend on your retirement savings to live, eat, and pay for shelter—the basics. If you’re not working, that money is your only source of income.”

Are you convinced?

With the industry gurus taking the same side of the coin, it seems pretty convincing that saving for retirement should be a priority over saving for college. I was part of this crowd for years until my oldest daughter entered her sophomore year of high school. I started looking at data and noticed these articles, which pointed towards studies in which parents took money out of their retirement accounts to pay for college. The data and studies were verified.

However, two items started making me question this advice. First, I hadn’t read an article with any numbers that stated why saving for retirement over college was better. Second, I started understanding why parents pull money out of retirement accounts to help pay for college. I’m not advocating this as a smart move, but rather acknowledging an understanding of behavior. I’m in the same situation as the middle-class parents. Advice from high-income earners (likely many of the financial gurus noted above) seems to make the subject a little less relatable from an emotional standpoint. We parent, live, and make choices emotionally.

Contrarian standard

In 2015, Mark Kantrowitz, a financial aid expert, wrote an article for Time.com called “Saving for College vs. Saving for Retirement: Why the Conventional Wisdom is Wrong.” Mark did the calculations and reviewed a couple of scenarios while dispelling financial planning myths.

– You can’t take out loans for retirement. Simply put, a couple over the age of 62 who has adequate home equity may take out a reverse mortgage or reverse equity line of credit.

– In fact, borrowing money to pay for college was a bad idea. Check out the article for the data. (Exploring it in detail here would make this article too long.)

Does it ever make sense to borrow money to pay for college?

Mark’s article highlights a specific situation. “The only time borrowing for college costs is financially beneficial is when the interest rates on parent loans are lower than the equivalent long-term earnings rate on your investments. But that just doesn’t happen very often.”

Currently, Direct PLUS loans carry an interest rate of 7%. Most financial plans assume rates of return of between 5%-6.5% depending on the portfolio, planner, and timeline.

Why does the financial services industry tell parents to save for retirement first?

To start, there’s a conflict. As I noted in my Current State of Affairs post, most advisors earn a commission for selling a product or they receive compensation from the assets they manage. Few charge by the hour or charge a flat fee. These same people and institutions will help families look for ways to fund goals that don’t take money away from the generation of revenue. Looking at the conflict another way, college will be coming before retirement and is less expensive. From the advisor’s perspective, the parent or student should take out a loan. The goal is funded and the advisor isn’t paid less. The loan will be dealt with later.

Next, outside of a few individuals, the industry doesn’t know how college funding works. Savings, loans, scholarships, work-study programs, class hours taken – these all influence the cost of college. Few if any discussions or works are available about how to shop for college. Families must match the student with the best college from the beginning; this can reduce time in school and transfers, the latter of which increases costs.

The reality is that parents will likely be on the hook for at least some of the student loan debt if they haven’t saved. The federal government will allow only $27,000 in student loan debt over four years with Stafford loans ($31,000 between subsidized and unsubsidized). The rest will come from either PLUS loans, private loans, or home equity. PLUS loans require a parent to participate, and private loans usually require a cosigner. This, again, places the matter back in the parent’s lap. The solution is to make college funding part of a family’s plan to shop for and save on higher education.

How many advisors and financial service professionals work in the trenches?

Based on my experience, very few (specifically, doing things like helping families fill out the FAFSA). Personally, I enjoy volunteering twice a year at College Goal Sunday. Families bring in their information and we walk through the FAFSA. No selling, just helping kids get into school and giving information to Mom and Dad.

Beyond the conflict and lack of understanding of college funding, the industry forgets that financial planning has value to the end client only when the plan is based on the client’s own values, not what we impose on the client. If a family ranks college funding over retirement, the advisor has the responsibility to build the plan that way AND to educate the family about the tradeoff between funding college and/or retirement. With more information, the parent better understands his or her choice and the cost of his or her decision.

What do you do?

– Take a deep breath. As a parent, I want the best that I can give my children. If that means working longer or having a little less at retirement, fine. I understand the choice and cost of this decision. Most parents have the same mindset of giving the best they can to their kids. To save for retirement over college seems contrary to how we parent and makes some parents feel as though they are being selfish.

Put your advisor through the paces and see how clear the college funding portion of your plan is. If it only states saving $x’s/month, you may be in trouble. Have a young child? Your advisor must, at a minimum, use a process or method to help beyond the savings component.

– If your student is in high school, use these articles to help you understand college funding. Download this worksheet to develop a college funding snapshot. This will help you understand how much the family can afford today.

Have more questions? Call to schedule a time for us to talk at 317-805-0840.