Retirement or College Savings-What Comes First?

Even as the economy begins its slow crawl back, college costs are continuing to rise.  That means parents are continuing to fight a tough battle between funding college and funding their own retirement.

In October, the College Board reported that the average published price of tuition and fees for in-state students at four-year U.S. public colleges was $7,020 for the 2009-10 school year, up $429 or 6.5 percent from a year ago. After adjusting for inflation, the average net price paid for tuition and fees by public four-year college students is lower overall in 2009-10 than it was five years ago, but higher than it was last year.  Private four-year colleges saw a smaller increase of $1,096 or 4.4 percent, but for a much higher average annual tuition of $26,273 for the school year.

Also in October, the Employee Benefit Research Institute (EBRI) and the Investment Company Institute (ICI) also reported in October that American workers who held 401(k) accounts consistently from 2003 through 2008 suffered a 24.3 percent average drop in their account balance during 2008’s bear market.

Despite these huge challenges, it’s particularly important for parents to make retirement their first priority. Kids can always take on loans and search for scholarship and grant funding to tide them over.  Parents can offer help in a better economy, but the momentum lost in saving for retirement is much tougher to replace.

And there are serious financial consequences to breaking into 401(k) and other tax- advantaged retirement savings to pay for college.  Parents tempted to do so should look for other alternatives.

A July 2007 Country Insurance and Financial Services survey found that not only did 25 percent of respondents think it would cost less than $50,000 to send a child to a four-year college, but that nearly half believe that saving for college is more important than their retirement. Most qualified experts  (including me) advise against. On average, public colleges have surpassed $50,000 in total costs when you add in books, room and board.

Before you choose between yourself and your child by raiding your retirement accounts, here’s what you should know:

You’ll escape an early distribution penalty, but…

Any withdrawals from an IRA you might take for your child or grandchild’s education (as well as your own or your spouse’s) can be withdrawn without the usual 10 percent penalty on early distributions before age 59 ½, but you’ll owe regular tax at your incremental tax rate on the withdrawal.  Ultimately, you really need to talk with a tax advisor or Certified Financial Planner™ (CFP®) professional (like me) to determine how your IRA withdrawals affect your tax liability and how they have to be reported on your Form 1040.

You might hurt your kid’s chances for financial aid:

The entire withdrawal from an IRA — whether taxable or not — must be included as income on the following year’s application for the Free Application for Federal Student Aid, or FAFSA. Family income does more to influence financial aid than the size of the family’s assets, and dipping into your IRA can potentially damage your child’s potential financial aid. Check with a trained financial planner who is well versed in financial aid strategy before you make such a move.

Most middle and upper income folks assume that they make too much money to qualify for financial aid.  I urge all students to apply for aid whether they think they qualify or not.  Many students whose parents report a six-figure income may qualify for grants, loans work-study or other financial assistance.

A ‘hardship withdrawal’ or loan from a 401 (k) plan should be a last resort:

Earlier this year, the Transamerica Center for Retirement Studies reported an increase in workers taking loans from their 401(k) and other work-based retirement savings. Eighteen percent of those surveyed reported that they took loans from their retirement plans in 2007 compared to 11 percent in 2006.

Keep in mind that while most retirement plans provide an option for hardship withdrawal for emergency medical or funeral expenses, the IRS restricts use of those funds for home purchases or tuition expenses. In any case, you’ll pay the tax on the withdrawal plus a 10% penalty on most financial hardship withdrawals.

So what do you do?  Besides talking to a tax professional, it makes sense to find time to speak with a CFP® professional to take a look at your overall financial situation so you can possibly find alternatives to raiding your retirement.  A trained planner can help you look over all the spending, saving and investment decisions you’ve made so far and seal up the leaks.  Then you can discover whether you have smarter options to pay your child’s tuition. They include:

Starting a search for scholarships and grants with your kid:

See if there are grants and scholarships not only in your community (think community foundations, high schools, local chambers of commerce), or within your industry or trade associations.  Understand what a prospective student’s college choices might offer in terms of aid from its endowment funds.  Also, some employers offer scholarships for their employees’ kids. Start searching online, at the office and by phone for such aid.

The website provides lots of information about strategies for saving for college, finding scholarships and applying for financial aid.

Negotiate a college work schedule for your child:

No one says that you have to pay 100 percent of your child’s education costs.  In fact, most students work harder when they have “skin in the game.”  A college sponsored work-study arrangement or just a regular full or part-time job while going to school is a great way for students to learn responsibility and how to manage money.

Whatever portion of college costs you decide to pay for your child, I generally suggest that parents let the children first pay for tuition and books and the parents pay for room, board and spending money.  This way, children will think twice about dropping or performing poorly in a class they know they’ll have to pay for again. Also, parents can incentivize kids by agreeing to pay for a larger percentage of college costs based on grades achieved.

Consider attending a commuter college:

Many local colleges and universities offer the same if not a better educational opportunity for students as going away for college.  If money is tight and the student qualifies for little in the way of grants or scholarships, living at home while attending college can be an excellent way to get an education while saving 40 to 50 percent of the total cost.

Fine-tuning your negotiating skills:

Parents need to become more aggressive about negotiating tuition, room, and board at colleges where either their children or they have been accepted. A financial planner with expertise in college planning can train parents to understand where those savings might be and how to ask for them.

Please feel free to get in touch with me or leave your comments or feedback here if you have any questions.  You can find more information about our services and how we can help at

Sam H. Fawaz CFP®, CPA is president of YDream Financial Services, Inc., a registered investment advisor. Sam is a Certified Financial Planner ( CFP ), Certified Public Accountant and registered member of the Financial Planning Association and the National Association of Personal Financial Advisors (NAPFA) fee-only financial planner group.  Sam has expertise in many areas of personal finance and wealth management and has always been fascinated with the role of money in society.  Helping others prosper and succeed has been Sam’s mission since he decided to dedicate his life to financial planning.  He specializes in entrepreneurs, professionals, company executives and their families. This column was produced by YDream Financial Services and the Financial Planning Association, the membership organization for the financial planning community. All material presented herein is believed to be reliable, but we cannot attest to its accuracy.  Investment recommendations may change and readers are urged to check with their investment advisors before making any planning or investment decisions.  Opinions expressed in this writing by Sam H. Fawaz are his own, may change without prior notice and should not be relied upon as a sole basis for making investment or planning decisions.

All material presented herein is believed to be reliable, but we cannot attest to its accuracy.  Investment recommendations may change and readers are urged to check with their investment advisors before making any investment decisions.  Opinions expressed in this writing by Sam H. Fawaz are his own, may change without prior notice and should not be relied upon as a basis for making investment or planning decisions.
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