Parents Are Robbing Retirement for College
Paying for your child's education is a laudable goal, but may not be realistic for some parents who could wind up jeopardizing their own financial future in order to help put their sons and daughters through college.
Parents who are saving for college frequently raid retirement funds — or plan to do so — to pay their child's skyrocketing tuition bills, according to a new study released today from the nation's largest student loan provider Sallie Mae. More parents are currently saving for their retirement than for their children's education, but these families often plan to draw from retirement savings to help cover the costs of college, especially as other goals — from building up a "rainy day" fund to increasing general savings — take priority. "The economy is putting pressure on families in terms of whether they're saving, how much they're saving and where they're saving," said Sarah Ducich, senior vice president for public policy at Sallie Mae.
The report "How America Saves For College" surveyed more than 1,600 parents with children ages 18 or younger and found half of parents said they were focused on college savings, while 60 percent were focused on saving for retirement. But if they have to choose, parents are opting to boost their retirement savings — 42 percent of parents who are not saving for college said they are saving for retirement.
The good news: More than three-quarters of those parents surveyed who are saving for college are also focused on saving for retirement.
The bad news: Many of those families who say they are saving for college also admit that they are doing so through their retirement fund. One-third intend to use these savings for college. The other two-thirds say that they would use their retirement savings to pay for college, only if necessary.
(Read More: Downsizing the Home for Retirement: Is It Worth It?)
Families are more likely to use retirement savings to fund college as their children get older and the urgency intensifies. Less than half (44 percent) of families with children under age 6 would use retirement savings to pay for college, while more than seven in 10 (74 percent) families with teens would use their retirement for college, the survey found.
How much retirement money are they putting toward tuition and other college expenses?
Nearly 6 percent of parents in the thick of paying for college are drawing on retirement funds by taking a loan or withdrawal of about $6,475 on average, according to a 2012 Sallie Mae survey.
But here's the problem: Most parents don't realize paying for college with money withdrawn from a retirement account can result in a double whammy. First, the withdrawal can count as income which is taxable. Plus, with that additional income, you'll reduce your financial aid eligibility the following year.
"Between the tax impact and the reduction in aid eligibility, the family may net very little return on their investment," said Mark Kantrowitz, publisher of Fastweb.com, a free scholarship matching service. "It also sacrifices retirement funds," he said.
By borrowing from your 401(k) or IRA, parents not only reduce their retirement balance, but also miss out accruing interest. And if you're under age 59 1/2 and take a loan from your 401(k), you'll have to pay back the loan with interest in five years, or immediately, if you change employers.
(Read More: A Wealthy Nation That Can't Afford to Retire)
Jump Start Your College Savings
So how can parents avoid raiding their retirement funds for college? It sounds very simple. Make a plan to save. The Sallie Mae study showed 70 percent of families with a set goal to save for college are confident they will save 10 percent of future college costs.
To ramp up college savings, start funding or add more money to a 529 college savings plan. A 529 college savings plan allows you to save money for college and then withdraw the funds for qualified college expenses tax-free. Studies show that people who use 529 college savings plans are more successful college savers than those without 529 plans.
The College Savings Foundation's 2012 parent survey found that 22 percent of 529 owners have saved between $10,001 and $25,000, while only 9 percent of non-529 account owners have saved a similar amount. Likewise, 18 percent of 529 plan owners reported saving between $25,001 and $50,000. Only 4 percent of non-529 account owners managed to save as much. Overall, parents who have not opened a 529 plan are the least effective college savers — nearly half have no college savings.
To help jump start your college savings, here are a few tips from Kantrowitz, who is also publisher of the financial aid information site FinAid.org:
- Make savings automatic, so you don't have to think to save.
- Increase the amount you save each year. You will quickly get used to not having the money in your checking account.
- Whenever you get a windfall, such as a big income tax refund or inheritance, contribute all or part of it to the college savings plan.
- When expenses change, resulting in some savings, devote the savings to college. "When your child no longer needs diapers or daycare, for example, redirect the savings to their college fund," Kantrowitz says.
- Use a rebating program, like Upromise, to help build your 529 plan faster.
- Finally, get grandparents and other relatives involved. Have them contribute to your children's 529 plans instead of giving gifts on birthdays and holidays.
Make college savings a true, family affair.