It is widely recommended in the financial world that you prioritize your retirement savings over college savings for your children. I agree with this advice. Yet, I run into people all the time who are not following it. Perhaps it is because college often arrives a decade or more earlier than retirement so it seems natural to save for college first and then turn your attention toward retirement. To make matters worse, I find some people prioritizing saving for their children’s college over paying off their own education! Now, if you’re milking along some 1.1% student loan while investing aggressively in a 529, fine, but for the most part, prioritize paying for your own education first, then your retirement, then your children’s education. In this post, I’ll give seven reasons why.
1. You can’t borrow for retirement
One of the best reasons to save for retirement first is that you (and thus your child) can borrow for an education, but you can’t borrow for retirement. That’s not entirely true; you can borrow against your portfolio, your life insurance cash value, and your home, but you can’t borrow without collateral (at least not very much, I suppose lots of retirees die with credit card debt) like you can with student loans.
2. There are four pillars of paying for college
Regular readers have heard me talk about the four pillars of paying for college. Despite reason # 1 above, none of those pillars involve debt (although I suppose some debt is okay for professional/graduate school so long as it brings a degree with high earning potential.) The pillars are:
- School selection: Pick a school you and your child can afford to pay for without debt.
- Student contribution: This includes merit scholarships, the child’s savings, summer work, and part-time work during school. The children of most high-income professionals won’t qualify for need-based aid.
- Parental savings: ESAs, 529s etc.
- Parental cash flow: A high-income professional can likely contribute something from current earnings toward college
Since there are three other pillars to rely on, even if pillar three is minimal, college can still happen. That’s less and less the case with retirement, as Social Security’s full retirement age is slowly climbing and pensions are going the way of the dodo bird.
3. You help others from a position of strength
As a general rule, you can only pull people up to where you are. It is difficult (not to mention unwise) to provide significant financial help to someone else when you are financially insecure yourself. Like in the airplane when the oxygen masks drop — put yours on first, then help your children.
4. You can use retirement money to pay for college
Here’s another novel thought- money is fungible. If heaven forbid, you save too much for retirement and don’t have enough to cover what you want to pay for college, you can take retirement money and use it for college. Some of it is probably in a taxable account, so no penalty to withdraw it (plus you may even get some tax deduction or credit for paying directly.) Roth IRA contributions can be taken out for any purpose at any time penalty-free and tax-free. IRA earnings can be taken out penalty-free to pay for education. You could borrow against a 401(k) if you wanted, although I don’t recommend it. You could even withdraw retirement account money and pay any taxes and penalties due.
5. Retirement tax benefits are way better
There are some tax benefits associated with saving for college, they’re pretty minor though. In many states, you don’t get a deduction/credit at all, just the tax-free growth and withdrawals. Retirement accounts, on the other hand, are often the best tax break available to doctors. If you need another reason to prioritize retirement over college savings, the tax breaks are a big one.
6. Retirement accounts can be stretched and get better asset protection
While 529 account beneficiaries can be changed, allowing the money to continue to grow in a tax-protected way for another decade or two, that pales in comparison to the benefits of a stretch IRA, or even better, a stretch Roth IRA. 529 accounts also have limited asset protection in the rare event you are sued for more than policy limits. It really varies quite a bit between states. Retirement accounts, on the other hand, receive excellent protection in nearly every state.
7. Much greater variability of price for college than retirement
The price of a college education is amazingly variable. It can range from a mid-four figure amount per year to a mid-five-figure amount per year, a tenfold difference for a similar product! Retirement costs do have some variability (notice how many retirees downsize or move South to a lower tax state), but not nearly as much. Unlike college, spending dramatically less on retirement often results in a “less attractive product” (i.e., lifestyle).
There you go. Seven reasons why you should prioritize retirement savings over college savings. As always, moderation in all things, but don’t make the mistake of pouring all your resources into your children and then expecting them to support you in your old change. They may not be able to, may resent it, or simply may not do it at all!
James M. Dahle is the author of The White Coat Investor: A Doctor’s Guide To Personal Finance And Investing and blogs at the White Coat Investor. He is the creator of Fire Your Financial Advisor!, a high-quality 12 module course with a little over 7 hours of videos and screencasts, a pre-test, section quizzes with answer explanations, and a final exam. The goal is to take a high income professional from square one, teach them financial literacy and help them write their own financial plan.
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