Saving For College - Can I Do It?
We want the best for our children. One of the most important goals for a parent is ensuring that our children are as well-equipped as possible for the challenges of their adult lives. Saving for college is a massive financial undertaking for a parent. In order to be successful, you need to use the right strategies to get there.
Today we will begin a three-part series exploring how to incorporate saving for college into your overall financial plan.
As I’m sure you’re aware, college costs having been increasing faster than the rate of inflation for some time now. Saving for college today requires more than simply setting aside a few dollars or assuming your child can get a summer job to cover it. Funding education is a significant expense and it takes real planning to get there.
Are your other financial affairs in order?
Having our children’s interests in mind is certainly important, but funding a child’s college should not come at the expense of your own financial well-being. Before you begin setting aside funds for college, make sure you can check these boxes first:
- Emergency fund of 3-6 months of expenses
- No credit card debt
- Contributing the maximum to your 401(k) (or other work-sponsored retirement plan)
- Contributing the maximum to an IRA
All of these items should come before you begin setting money aside for your child’s education. It doesn’t do your children any good to help them out with college only to have the burden of your care and expenses fall onto them later in life. By not giving proper attention to your own financial plan, you may run out of money 15 or 20 years into retirement. At that point, finding new employment or income streams in retirement may be difficult or impossible. If push comes to shove, in most cases, I would recommend choosing to fund retirement before college.
To further add fuel to the “take care of yourself first” cause, there are provisions under 401(k)s and IRAs that will allow you to utilize some of the assets in these accounts for college when the time comes.
Traditional & Roth IRAs
With a Traditional IRA, you may take distributions for higher education expenses. You will still pay income tax from the amount taken, but this is no different than taking a qualified withdrawal in retirement. You will want to ensure you comply with all of the IRS rules before digging in to your IRA.
Roth IRAs can offer further advantages. In these accounts you can withdraw your contributions at any time, for any reason. For instance, if you contributed $50,000 to a Roth IRA that has grown to $100,000, the first $50,000 you withdraw is income tax and penalty free. Amounts after that will be subject to income tax, but still avoid the 10% penalty if used for higher education expenses.
Another option would be to take a loan from your 401(k), if your employer’s plan allows for loans. This can give you access to some extra funding with the built-in caveat that you have to pay yourself back. As long as you have the latitude in your budget to make the repayments back to your 401(k), this can be a valuable tool.
However, violating the loan repayment rules on a 401(k) can result in severe tax consequences. Missing payments can disqualify the loan you took and the IRS could treat it as an outright distribution. This would subject the amount of the loan to both taxes and penalty.
My point in highlighting these retirement-focused accounts is to illustrate that funding your own retirement accounts first is typically a more prudent approach. These accounts can still be used to help a child with college, should you choose to use them. If your child ends up not attending college, or spending less on college than originally planned, these accounts still receive favorable tax treatment for your goals. The downside of specifically funding accounts for college, such as a 529 plan, is that if these assets aren’t used for qualified education expenses, then you may pay a penalty to use them for other needs.
In part two, we will explore how much college is going to cost for your children and how much you need to be saving to get there.