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Should I Save for Retirement or College?

Balancing Your Savings Needs With Your Children's Education.

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College? Retirement? Which jar do you fill first?
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Are you weighing whether to give up your regular retirement contribution and move the funds in a college savings plan for your kids? The answer to the question retirement vs. college is an unequivocal "Retirement!" As a mom with two kids that had better be going to college, I know how hard it is to fit everything into the budget. Still, retirement savings is a priority in my family. Here's why it should be in yours, too. 

Why You Should Save for Retirement Before College

There are many reasons why funding your 401(k) or individual retirement plan should take priority over funding a college savings plan. It may seem selfish, but your needs in retirement are just as important (and arguably more important) than funding your child's education. How is that possible, you may ask? Your son or daughter will have plenty of access to educational funding once they get to college. And while student loans aren't the ideal, they are typically offered at low rates with flexible repayment options that your child has time to make good on. Whereas if you are ill or unable to work in your senior years, your access to income will be more limited, with fewer sources of funding or future income available to you. Your kids have their whole lives ahead of them. You have a goals you need to achieve within a limited timeframe. Do yourself the favor of a little selfishness.

Then there's the unselfish argument for maxing out a 401(k) or IRA: retirement savings in a 401(k) or traditional IRA aren't counted in your assets when considering financial aid qualification. That means the more of your money you have stashed away for retirement, the better your kids' potential chances for a grant, scholarship, work program or loan (if you are otherwise eligible, that is).

A 401(k) or Roth Can Be a Potential Source of Funding

If you have a 401(k) with an employer match and a loan program, making the maximum contribution is an easy choice. Why? First consider the employer match. The company will give you a little bit more money if you save for your own retirement, tax deferred. It's is kind of like a salary bonus that you should be taking advantage of, and it helps your savings accumulate more quickly. Plus, if you are completely strapped, you can borrow from the 401(k). This is not a recommendation to take a 401(k) loan—under the best circumstances, it's never a good idea to touch your retirement funds before retirement. But it's nice to know the option is there if you need it. With a 401(k) loan, you pay yourself back with interest. So it's kind of a win-win. The only thing to worry about is your job stability. If you have an outstanding 401(k) loan and you lose or leave your job, you must pay the balance due immediately.

Attempt to Max Out Retirement Contributions Before College Contributions

In 2013, individuals can contribute up to $17,500 to a 401(k), or up to $23,000 if you are older than age 50. If you have maxed that and want to put more away, you can choose a traditional Individual Retirement Account or a Roth IRA. You can put up to $5,500 into each in 2013 ($6,500 if you are over 50). There are no tax deductions for investing in a Roth (you may qualify for deductions to a traditional IRA), but your after-tax money grows without future tax consequences. And you can withdraw contributions from a Roth before retirement without penalty (restrictions apply, take a look at Roth withdrawal rules). Yes, it's also an option for college savings, but you would be wiser to hoard your Roth money for yourself.

Time Roth IRA Conversions Around High School and College Years

On a side note: If you would like a Roth IRA and have considered a conversion to a Roth from your traditional IRA, watch the timing. You can do it while your children are still young and it won't impact your child's eligibility for financial aid. But if you do it while your child is in college, the converted funds become income and can hurt your needs-based ratios and increase the family's expected contribution. Unless you do it before the kids are well into high school, it's best to hold out on that conversion until after the kids have graduated.

Add a 529 Plan Last

If you've done all you can retirement-wise, a college fund is a great idea. A 529 plan can be a good choice, particularly if you live in one of the states that allow a tax deduction for 529 contributions. Money grows tax free for education, contributions can be taken out regularly with your paycheck. It's just like a 401(k) for college, but you choose them according to state. You don't have to invest in your state's plan (unless, of course, you are eligible for a tax deduction).

With the money inside the plan you can choose a plug-and-play type investment where a manager starts with a growth strategy and becomes more conservative as the child nears college age. Or you can make some self-directed choices. If your 529 plan isn't used by the intended child, it can be used by a sibling or cousin. Or you can simply withdraw the funds and pay applicable taxes and fees. If your kids never make it to college, think of it as a bonus retirement fund.

Yes, the benefits of a 529 plan for those who don't get a state tax deduction on contributions are a lot like those offered by a Roth IRA. But again, you only get $5,500 a year to contribute to a Roth. Given the choice, you should use it for your retirement and not education. Always consider retirement first before making a contribution to college savings. Retirement is the clear priority.

The content on this site is provided for information and discussion purposes only. It is not intended to be professional financial advice and should not be the sole basis for your investment or tax planning decisions. Under no circumstances does this information represent a recommendation to buy or sell securities.

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