How can parents balance paying for college and saving for retirement?
- Parents must have a clear financial plan in order to address both college expenses and saving for retirement.
- Clear goals and expectations can help you save for competing priorities.
- Take advantage of any tax benefits that 401(k) and Section 529 plans offer whenever possible.
"We understand that every parent must plan to retire, yet wants to give their child the tools he or she needs to be successful," says Richard Polimeni, director, Education Savings Program, Merrill Lynch. Consider the following four-pronged strategy to address both:
1. Estimate the Costs
Online calculators, including the Merrill Edge® College Planning Tool, can be put to good use. "It's hard to invest for a goal if you have no idea what it will cost," Polimeni says. He advises parents to invest enough for a four-year public college and ask their child to help cover additional costs through part-time work and scholarships if he or she wants to attend a more expensive school.
As for retirement, your first step should involve more than just a calculator, advises Bill Hunter, director, IRA Product Management, Merrill Lynch. "You need to develop a realistic view of how you and your spouse or partner envision your retirement years," he says. Once you have that important conversation, you can use online tools such as the Merrill Edge Retirement Evaluator to help you estimate the cost of that lifestyle as a percentage of your current income and calculate your retirement savings needs.
2. Assess Your Situation
Over the past decade, college costs have risen 5.6% annually above the rate of inflation.1 Using the MerrillEdge.com college calculator, you can see that if you have a 5-year-old and are starting from scratch, you'll need to save close to $600 a month to cover four years of public in-state college starting in 2024.2 Few people can afford to save $600 a month in addition to what they should be allocating for retirement. That means you may need to make some trade-offs regarding your goals and also seek opportunities to boost your savings.
Fortunately, parents rarely have to foot the entire college bill. In 2011-2012, grant aid, including federal tax benefits, averaged 33.6% of total costs for students at four-year public colleges.3
Unfortunately, aside from Social Security and the increasingly uncommon pension, most people are responsible for funding their own retirement. With greater longevity and rising health care costs, retirement is growing more expensive. You will likely need to fund Medicare and supplemental plan premiums, in addition to co-pays and deductibles. This is in addition to paying for services not covered by traditional Medicare, such as vision, dental and long-term needs.
3. Plan Your Savings
Once you know where you stand and what your goals are, it's important to create a clear savings plan. "People balance goals in fitness by doing a cardiovascular workout on some days and lifting weights on others," Hunter says. "The same can be said for balancing your twin goals of financing your child's college education and saving for your retirement." In general, contribute enough to keep both on track.
At a minimum, take advantage of any tax benefits and "free money" in the form of your employer's matching 401(k) contributions. If you have a 401(k) plan and your employer offers matching contributions, try to contribute enough to earn that match. If you don't have a 401(k) plan, consider contributing to an IRA. If you weren't able to put away enough money in the past, take advantage of catch-up contributions: Those age 50 or over can contribute an additional $5,500 to a 401(k) and an extra $1,000 to an IRA in 2012. (Future annual amounts may vary.) For college savings, consider establishing a 529 plan, which typically offers more generous tax benefits than other college savings vehicles. Many states offer additional incentives in the form of tax deductions for contributions made to their Section 529 plan.
4. Re-evaluate and Adjust
Both Hunter and Polimeni recommend reviewing your savings plans for both college and retirement at least once a year. "It's an opportunity to re-evaluate options and see whether you're on track to meet your goals," Polimeni says. If you're falling short, you may need to trim expenses. For example, re-evaluate your wants and needs, and perhaps opt for a less expensive vacation or keep your car longer. You might also decide to cover less of the college price tag, assign more responsibility for funding to your children or adopt a more aggressive investing approach. And if you unexpectedly have extra money, such as savings from a mortgage refinance or a bonus, try to put it toward savings, whether it's for college or for retirement.
Another solution that can help with both goals, Hunter says, "is to plan to work part time in retirement or to delay retirement, which can go a long way toward improving your savings outlook."
There's no single answer as to how to save for college and retirement simultaneously. There may be trade-offs. The right balance changes for each situation. "It's personal," Hunter says. "The only wrong decision is ignoring that these are both priorities that need your attention — today." The sooner you start, the easier it may be to achieve your goals for the life you want, while still having time on your side.