We all know that saving for retirement is not simple, but factor in a child’s college fees and you’re complicating the matter even further. So what are the options available to you when considering their future?
The temptation to put your child’s college fees first over your own retirement is obvious, be wary of opting for this method. Children have a longer time to pay off student loans than you would have to restore your retirement savings, so taking your future self’s money can damage your retirement plan. Consider looking at other options for your child instead, such as them working while studying, or delaying college to save. Opt for a cheaper school or consider benefits from the military. You could even suggest your child forgoes student lodgings to live at home throughout their studies, though this will most likely have some resistance from a child hoping to spread their wings.
Many parents consider postponing retirement to pay for college, and while this is an option for some, it doesn’t take into account the “what ifs” of life. What if, for example, you become ill and unable to work? Or what would happen if you were made redundant from your company and found it difficult to get back on the employment ladder? It’s thought that almost 25% of retirees had to take retirement due to unavoidable circumstances. Cutting back on non-essentials can help counter the costs of college.
It is believed that seniors have nearly six times the amount of education debt than they did 25 years ago thanks to taking student loans later in life to pay for their children’s or grandchildren’s college fees, putting themselves at risk of default on federal student loans. In 2013, 156,000 Americans defaulted, a figure three-time higher than 2006. Those that default on federal student loans are required to pay a percentage of their Social Security payments to pay off the backlog.
Those using retirement plans, like the 401(k) to pay for college can find that this can come at a substantial cost. Removing money from these schemes before turning 59.5 will trigger a sizable 10% penalty, as well as income tax charges which can damage an account badly. It’s worth noting that the IRS allows hardship withdrawals for college, but these are difficult to qualify for, and shouldn’t be relied upon. Of the investment options, Roth 401(s) or Roth IRAs are good choices. These are more flexible than the 401(k) options, and allow contributions to be taken out for any reason without tax or penalties, making them useful for parents of kids who receive scholarships or don’t attend college. The same doesn’t apply to investment gains taken out before age 59.5, which are penalized and taxed. A similar option are 529 plans, which are also free from tax and state tax. IRA money can also be used for college, but any withdrawals will be taxed.
Loans are an option, but loans from a 401(k) account means that you have to sell assets in the account, rather than just using them as collateral. Any gains from these holdings are lost until the assets are purchased again, and they usually have to be paid back in 5 years, or penalties and taxes apply. You could opt for a home-equity loan against the family home to pay for college, though variable rates can jump steeply. Borrowing against the home undermines its security by leaving less equity to extract in a reverse or downsizing mortgage.
Lastly, some consideration should go to custodial UTMA (Uniform Transfer to Minors Act), and UGMA (Uniform Gift to Minors Act) accounts allowing money to be gifted to minors without incurring gift taxes. These are controlled by the child when they turn 18/21 depending on the state, allowing money to be used solely for the child’s benefit. These may reduce the possibility of gaining financial aid as children’s assets weigh more heavily into the calculations than adults.
Whatever option you choose, we’re sure that you’ll agree that planning is the safest option to protect both your future and the child’s financial future, to avoid the dreaded financial aid loans.