The cost of a college education has risen significantly over the past 40 years. In fact, student loans make up the largest piece of non-housing debt in the United States — more than both credit cards and auto loans. The average cost of a four-year education is more than $100,000, which is difficult for many students in less lucrative fields to pay back.
Nobody wants to saddle their children with debt, so it’s tempting to try and help them out. After their house, retirement savings is the largest nest egg for older adults. It may seem tempting to withdraw money from these accounts to help children pay for college, but doing so would be a costly mistake under most circumstances.
Let’s take a look at the best way to save for college and why you shouldn’t dip into your retirement savings to help pay for your kids’ college if they come up short.
How to Save for College
The best way to save for college is to plan ahead using a tax-advantaged qualified tuition, or 529 plan. In addition to broker or advisor plans, many states offer direct-sold education savings plans that eliminate the need to pay broker-related fees. You may even be able to avoid administrative or maintenance fees depending on the plan.
There are two types of 529 plans to consider:
- Prepaid Tuition Plans let a saver or account holder purchase units or credits at participating colleges and universities for future tuition and mandatory fees at current prices for the beneficiary. The only exception is that they cannot pay for future room and board or elementary or secondary schools.
- Education Savings Plans let a saver open an investment account to save for the beneficiary’s future qualified higher education expenses, including tuition, mandatory fees, and room and board. These plans can also be used to pay for up to $10,000 per year of tuition at any public, private, or religious elementary or secondary school.
The tax benefits of a 529 plan depend on the state. In general, you may withdraw funds for qualified educational expenses without paying tax on the withdrawals. The catch is that withdrawals for non-education purposes may result in federal income tax plus a 10% federal tax penalty on any earnings. These plans may also impact financial aid eligibility.
College savings programs are a great way to plan for the future, but you should not prioritize saving for your kids’ higher education costs ahead of your own retirement. You will have fewer options to fund your retirement, it has a higher probability of occurring, and will cost more. For all these reasons, you should be maxing out your retirement contributions before starting a college savings plan for your kids.
Don’t Dip into Retirement
Most financial advisors recommend against dipping into retirement savings to help pay for college for a variety of reasons. In fact, depending on market conditions, paying for a four-year college education could set retirement back six to ten years! It’s easier for your children to pay off student loans than for you to work in retirement.
There are several reasons why:
- There are plenty of education loans available, but you cannot borrow money to fund your retirement.
- Significant withdrawals from retirement funds are difficult to replenish — especially at an older age.
- The interest rates on student loans is lower than the long-term average stock market return.
- You may have to pay a tax penalty if you withdraw funds early from your retirement account.
- You may not be eligible for financial aid if you withdraw funds from retirement since it counts as income that year.
If you have overfunded your retirement and you want to help a child pay for college, you should consult with a financial advisor before making any withdrawals. You could still face early withdrawal penalties and the income could impact eligibility for financial aid. There may be other options available to help your child and avoid these issues.
Other Ways to Pay for College
Families that haven’t built up a college savings plan and want to help their children afford college have many options to either offset the costs or help come up with other money.
Scholarships are a great way to pay for college because they don’t require any repayment. While you have to qualify for a scholarship, there are many different qualifications and websites out there to help students find scholarships that fit their specific qualifications. Local companies, banks, and service organizations may also offer scholarships.
Concurrent enrollment in high school and testing out of classes in college can reduce credit requirements for graduation. Since most universities charge per credit, these reductions could translate to a significant cost savings. AP classes are the most popular example of these strategies, but so-called CLEP tests are another option for many colleges.
Part-time jobs, internships, and student research positions are three ways to earn an extra income in school while simultaneously building valuable career skills — they can even lead to a full-time position after you’ve graduated. College career centers are a great starting point for finding job leads, while college job fairs may be another great option.
Loans Aren’t All Bad News
Most student loans have lower interest rates than other popular types of loans. More importantly, these interest rates are much lower than long-term average stock market returns. By selling stocks to pay for college, you could be foregoing an average of 7% annual returns from the stock markets to save an average of 3.5% to 4.5% interest charged by student loan lenders.
Some student loans also have flexible repayment terms. For instance, you may have forbearance on payments when you’re in school, active duty in the military or volunteering for a qualified public service organization. Many loans also provide forbearance in times of financial hardship or may offer lower payment options if your income falls below certain thresholds.
Loan forgiveness programs are another option that could make the debt more manageable after-the-fact. A great example are the loan forgiveness programs available for teachers that complete certain five-year state-sponsored programs. These programs are designed to encourage teachers to take hard-to-fill jobs in exchange for loan forgiveness.
The Bottom Line
The cost of college is on the rise, but that doesn’t mean that dipping into retirement savings is a good idea. In fact, helping pay for four years of tuition could set your retirement back up to ten years! It’s better to start savings for college in advance, if possible, or help your children find other ways to make college more affordable.
If you’re already in retirement and looking for a way to generate an income from your savings, the Snider Investment Method could be an alternative to fixed income investments. The strategy involves selling covered call options against a portfolio of stocks to generate a predictable bond-like income while remaining in the market.