As a parent, you instinctively put your children first. While that impulse serves our species well in moments of physical danger, it doesn’t help your long-term financial planning.
Quite the opposite, as it turns out. Diverting money from your retirement to cover your kids’ college expenses can lead to disaster — for both you and them.
As you plan your financial future, keep the following financial implications of saving for retirement versus your children’s college education in mind.
Should You Save for Your Child’s College Education or Your Retirement?
As you organize your thoughts around which type of savings to prioritize, consider the following questions. But if you can’t comfortably invest in both, you should generally put your retirement first.
What Are Your Retirement Goals?
I know aspiring retirees who want nothing more than to drive around the country in a camper van and eventually settle in a tiny cottage. And I know plenty of others who want to jetset around the world, then settle in a sprawling high-end ranch house.
If you have only modest and affordable lifestyle goals in retirement, you only need a modest nest egg. In fact, many followers of the FIRE movement use a strategy called “lean FIRE” where they keep their living expenses so low that they can quickly build enough passive income to cover them. That enables them to retire young.
If you want to live a swankier lifestyle in retirement, plan on socking away far more money for your golden years.
Ironically, living lean in your working years helps you save far more money for a plush retirement. By living on a small fraction of your income, you can maintain a huge savings rate, building wealth quickly.
Are You on Track With Your Retirement Savings?
If you’re behind on your retirement investments, you have little choice in the matter. You must catch up on retirement savings to ensure you have enough to live on when you stop working.
Your children have dozens of options to pay for college, which they can combine for a multi-pronged approach. Most Americans only have one sure way to pay for their retirement however: their savings.
Sure, you could take out a reverse mortgage if you have enormous equity in your home. And you’ll likely receive something from Social Security, although the buying power of Social Security benefits has been declining for decades.
Take an uncomfortably close look at how much you need to save for retirement. Ask yourself whether you’re on track before even considering college savings for your children.
How Much Financial Aid Might Your Child Qualify for?
Colleges, governments, and nonprofits give out scholarships and grants for many reasons.
Some hinge on merit. If your child excels at academics or athletics, or better yet both, they should have ample opportunities for merit and athletic scholarships.
Others revolve around need. Promising students from lower-income families or historically marginalized communities can apply for countless scholarships and grants.
And then there are seemingly endless niche scholarships and grants. Some get downright strange, such as the Tall Clubs International scholarship for tall people.
Don’t expect any guarantees that your child will receive financial aid, but gifted students can usually find significant help with tuition.
Will You Be Helping Pay off Your Child’s Student Loans?
Be honest with yourself. Are you a pushover parent, always bailing out your kid when they get in trouble?
If you or your spouse just can’t help yourselves in rescuing your child, there’s a good chance you’ll crumble and pay off your child’s student loans for them at some point. A point after which lenders have already collected substantial interest and fees.
In this case, it often makes more sense to just plan for it now and avoid those fees and interest. By all means, go ahead and invest money to help your kids with college tuition.
Just don’t do it at the expense of your own retirement. When you prioritize saving for your kids’ education, you need to spend less on lifestyle expenses so that you can save and invest more money. In other words, you need to make some sacrifices.
Bottom Line: Pay Yourself First
As you debate whether you should help your kids with college, recognize one important point. It’s far worse to run out of money in retirement and ask to move in with your grown children, or constantly hit them up for money, than it is to leave them to their own devices to pay for college.
If you don’t help them with university costs, you can support them in plenty of other ways. Help them research and apply for scholarships and grants or pick out where they want to go to college in the first place. These types of assistance ensure they get the best value from their education while stretching their tuition dollars further.
Your kids can piece together their tuition money, between scholarships, grants, part-time jobs, student loans, and a dozen other options. But if you run out of money in retirement, you may have to move in with your children or into a depressing senior living facility.
If you exceed your retirement target and find yourself with unneeded savings after you retire, use the excess to help out your kids later in life. They’d appreciate it if you paid off their student loans or helped them with the down payment on their first house.
How to Save for College and Retirement at the Same Time
Fortunately, you don’t always have to choose between saving for retirement and saving for your kids’ education.
Try the following tactics to make both happen simultaneously.
Consider a Roth IRA
To begin with, you can withdraw contributions tax- and penalty-free at any time. If your account has been open for at least five years, you can also withdraw investment gains penalty- and tax-free to use toward higher education costs like tuition, fees, books, and supplies.
Even if you opened your account less than five years ago, you can still withdraw earnings penalty free to go toward qualified education expenses, but you may owe income taxes on them. The same goes for traditional IRAs.
In short, start by maxing out your Roth IRA contributions each year, for great tax advantages without locking you into a single use.
Roth IRAs do come with income limits, however. In 2022, the ability to contribute starts phasing out at $129,000, and disappears entirely at $144,000. Higher earners can still take advantage of backdoor Roth contributions.
Maximize Employer 401(k) Matching
Some employers offer a 401(k) or similar retirement plan to their workers. And many go so far as to match your contributions, up to a certain percentage of your salary.
The employer match is free money — an instant 100% return on your investment. Take full advantage of it, no further discussion necessary.
Open an HSA
Strangely, health savings accounts (HSAs) offer the best tax benefits of any tax-advantaged account. You get to deduct the initial contribution, it grows tax-free, and you don’t have to pay taxes when you withdraw money either.
And while they may seem irrelevant for either retirement or college savings, rethink their use.
Later in life, you will need money for health-related expenses. Without an HSA, you’d need to pull that money from your savings account — or in an emergency, your retirement account or child’s college fund. Investment bank Fidelity estimates that the average retired couple spends $300,000 on health expenses from age 65 through the end of their lives.
In other words, saving up for health expenses won’t go to waste. The money has to come from somewhere, so you might as well avoid taxes on it.
Open a 529 Savings Plan — For Others to Fund
You can, of course, open a 529 college savings plan, specifically designated for education.
They offer similar tax benefits as Roth IRAs. You can withdraw the money tax-free when it comes time to pay for college.
But 529 college savings plans aren’t very flexible. If you withdraw funds for anything other than qualified education expenses, the IRS slaps you with a 10% penalty.
What’s a parent to do?
That’s easy. Open a 529 plan at your child’s birth, and tell every family member or friend who asks about gifts for your child to contribute to their 529 plan. Small gifts from many sources add up over time, especially when compounded over 18 years.
It offers the perfect way for grandparents to help cover college costs. And aunts, uncles, neighbors, and cousins once removed, for that matter.
Invest Through a Taxable Brokerage Account
We all love minimizing our tax bill. But sometimes flexibility counts for more than saving a little extra money. The simple fact is that your life, needs, finances, and goals will all look radically different in two decades. You can’t necessarily predict any of them that far in advance.
If you don’t have one already, open a free brokerage account and just start investing. If you don’t know what to invest in, open an account with a robo-advisor that chooses ideal investments for someone with your goals, risk tolerance, and age.
This account helps you build wealth automatically in the background each month without having to designate a use for it. Years from now, you can decide whether to chip in toward your kids’ tuition or leave your investment balance to grow for your retirement.
Invest in Real Estate
Imagine that the year your child is born, you buy a rental property. Over the next 18 years, you gradually pay down the mortgage, and your monthly payment toward it remains fixed, even as inflation drives the rent higher.
What started as a $20,000 down payment and $150 a month in cash flow could balloon to $200,000 in equity and $1,500 in monthly cash flow over the next two decades.
Between now and then, you could reinvest the profits into a 529 plan. You could then sell the property to cover any remaining tuition costs — or you could keep the golden goose and collect rental income in retirement.
Alternatively, consider another strategy. Your child turns 15 and doesn’t have a summer job, so you decide to “partner” with them on a house flip. You look at houses together, make offers, negotiate contracts, and buy one. You roll up your sleeves together and renovate the property, with the help of contractors as you need them.
Then, you market and sell the property for a tidy profit. You deposit that windfall into their 529 plan. Prepare to pay short-term capital gains taxes on those profits, but you may be able to dilute them through your partnership with your child, who sits in a lower tax bracket than you do.
After renovating the property, you could choose to keep it as a rental rather than selling. In that case, the cash flow can go directly into your child’s 529 plan, then toward tuition payments, and finally toward your retirement after they graduate.
Over the next few summers, you and your child collaborate on more deals together, all the while teaching them valuable skills like negotiation, home repairs, and managing contractors. Most of all, you teach them an investment mindset.
Finally, know that each state imposes its own limit on lifetime 529 plan contributions. Flip enough houses with your child, and you might just reach it.
When in doubt, talk it out — but not with just anybody. If you have nagging questions about saving for the future, sit down with a certified financial planner and ask away.
Your financial planner can work with you on a customized plan for your personal financial goals. Based on your income, retirement funds, and personal finances, they’ll help you save and invest enough for retirement, while also setting aside some money for your child’s college education.
I’ve discovered that the same mindset and lifestyle that helps you reach financial independence can also put you in a position to help your kids with college. A high savings rate, aggressive investment strategy, diverse passive income streams, and flexible active income all help position you to both replace your 9-5 job and have enough money to chip in towards tuition.
Consider many of the same FIRE investing strategies to help you contribute towards your kids’ tuition, not just ditch your day job.