Your 401(k) isn’t a college fund. Here’s a guide to paying for your kid’s education without sacrificing retirement.


By Jennifer Nelson

For this reason, financial advisors discourage parents from contributing to their children’s college fund at the expense of their own pension

This article is reprinted with permission from NextAvenue.org.

Mya Payton, 58, of southeastern Pennsylvania, is divorced and has four children, the last of whom is now in college. “For the time my children have been in college – from 2014 to now – their father has been willing to pay 50% of their tuition and some related expenses, leaving each child and me to fund the rest/ to find. ”

Payton has paid her share by liquidating most of her non-retirement savings, raising equity in her home, and forgoing all but the bare minimum for her self-employed retirement plan (and earning nothing in at least a year of contribution at all).

To help her last child, Payton said she’s considering cashing out some retirement savings next year when she turns 59 1/2 so she won’t have to pay the 10% prepayment penalty included in tax-advantaged retirement plans. Your goal is to “hopefully avoid it [student] loans.”

Is this a great idea or one of the worst financial mistakes parents can make?

Eric Nero, a board-certified financial planner and president of First-Step Wealth, a comprehensive wealth planning service in Saratoga Springs, New York, says many parents think tapping or stopping their retirement savings is a viable way to help their kids get through college to pay and graduate student loan free.

A big mistake made by many

In fact, he says, the resulting loss of compound interest, tax breaks, time and eligibility for financial assistance makes this one of the biggest financial mistakes parents make.

A 2022 Retirement Confidence Survey by the Employee Benefit Research Institute found that more than 4 in 10 working parents say they are reducing their savings for retirement because they are also saving for a child’s college education.

And a recent report by financial research firm Morningstar (MORN) states that parents who put money into a college fund instead of a retirement account could miss out on many thousands of dollars in investment gains, wealth growth and income tax breaks for a comfortable retirement.

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“In the vast majority of cases, taking savings out of a retirement plan and putting them in somewhere else is a very bad idea,” said Doug Carey, CFA, owner of WealthTrace, a Boulder, Colorado-based retirement and financial planning software company.

That’s because contributions to retirement plans like a 401(k) or a traditional IRA are exempt from both federal and state income taxes. Instead, when you withdraw money from these accounts, you pay taxes and are likely to be in a much lower tax bracket.

Additionally, Carey explains that a 529 plan is just pre-tax for state income taxes. If a couple’s marginal federal income tax rate is 32% and they pay $20,000 into a 529 plan instead of a 401(k) plan, they are missing out on $6,400 in federal income tax savings.

“Not only that,” he says, “but the lost $6,400 doesn’t earn interest over time because it wasn’t invested.”

Reasons to put retirement first

The following are other reasons financial advisors discourage parents from contributing to their children’s college fund at the expense of their own pension:

You cannot recoup lost time or taxes. As you get older, you won’t necessarily be able to work in the same high-paying job you had in your prime, so put off saving for retirement until your kids can financially graduate.

Layoffs, burnout and illnesses accumulate in the years leading up to retirement. And even a part-time job will not be enough to compensate for the missing contributions.

There are no retirement loans. While students can borrow to fund their education, parents cannot borrow to fund their retirement. Students typically have many years to pay off student loans; Such debts can even be forgiven depending on your child’s career, government policies, or military programs. In August 2022, President Biden forgiven borrowers $10,000 in federal student loans via executive order.

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Compound interest is powerful. Darren L.Colananni, CFP and wealth management consultant at Centurion Wealth in McLean, Virginia, likes to call compound interest the ninth wonder of the world. Let’s say you have $100,000 in a retirement account and are making 7% per year for 20 years. Assuming no further contributions are made, your nest egg would grow to $387,000. Now let’s take the same $100,000 with only 10 years to retire and assume a higher rate of return, say 10%.

“Even if you get a better return, your nest egg would only be $257,000,” says Colananni. “That’s $130,000, a huge difference. Having time in your retirement account is more important than having less time with a higher return.”

You can miss free money. Deciding to stop contributing to a 401(k) plan can hurt even more if it causes you to miss a company match. Many employers match employees’ 401(k) contributions up to a percentage of their salary. This is essentially free money and it is important to take it.

“It may be an even worse decision to withdraw money from a 401(k) plan to pay a student’s college tuition if the 401(k) plan owner is under 59 1/2 years old.” says Carey. You would have to pay a 10% penalty on the payout, as well as federal and state income taxes. Even if you are over 59 1/2, you would still owe income taxes on the payout, and the money would no longer grow tax-deferred within the plan.

Read: This is the most expensive state to be a college student – plus expert tips on how to save money

things to consider

Be careful not to burden the children. Carey finds it ironic that parents use their retirement savings to pay for their children’s college when it increases the likelihood that they will end up being a burden to their children because they run out of money in retirement. You can avoid this fate by investing in your retirement savings and earning interest on the money over time. Experts believe doing things differently means disappointing your children. If you fall short on your retirement savings, your adult children will have to support you for a day—something most of us would like to avoid.

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You jeopardize financial aid. Finally, withdrawing money from your retirement savings to fund college can make it harder to qualify for need-based grants and scholarships. Colleges do not count retirement savings when calculating student aid, instead treating withdrawals from retirement savings as income.

“Talk about a double whammy — less money for retirement and less financial aid, which means you may need more money to pay for college,” says Taren Coleman, a Chartered Retirement Planning Counselor at College Money Smart, a Service befitting college. tied students with institutions they can afford.

The same is true if you withdraw equity from your home—those dollars count as income in the grant’s needs-based calculation.

Read on: Amid inflation, here are some Americans making full use of their 401(k) plans

Helping your kids pay for college may sound noble—but not at the expense of your retirement savings. Instead, look for schools that will offer them the best value for their money, support their journey, and help them apply for any grants, scholarships, and other aids that are available to them without making a significant financial mistake for your retirement.

Jennifer Nelson is a Florida-based author who also writes for MSNBC, Fox News, and AARP.

This article is reprinted with permission from NextAvenue.org, (c) 2022 Twin Cities Public Television, Inc. All rights reserved.

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