With limited resources, which is the more important financial goal - saving for your retirement or saving for your child's college education? While many parents want to pay the entire cost of their child's college education, the reality is that there are a variety of ways to pay for that education - personal savings, financial aid, and loans. Unfortunately, there aren't similar options for your retirement. No one is likely to loan you money if you haven't saved enough for retirement. You may want to maximize your retirement savings, realizing that there are ways to use those savings to help with education costs. How can that strategy help when it comes time to send your child to college?
- Your retirement savings won't be considered in financial aid formulas. The federal financial aid formula does not consider retirement accounts, including 401(k) plans and individual retirement accounts (IRAs), when calculating your expected family contribution. For other assets, the formula assumes that 5.6% of the parents' assets and 20% of the student's assets will be used annually for college costs. Thus, you may actually increase your financial aid award by saving in retirement accounts.
- You can still use these retirement assets to help pay for college costs. Money in IRAs can be withdrawn to pay higher-education expenses before age 59.5 without incurring the 10% federal tax penalty, although income taxes will be assessed on the taxable portion of the distribution. If the money is withdrawn from a Roth IRA, your contributions can be withdrawn at any time without penalty or taxes, while earnings can be withdrawn before age 59.5 by paying income taxes but not the 10% tax penalty. With 401(k) plans, you typically can't withdraw the money before retirement age unless it is for a hardship withdrawal, but you can borrow funds, if permitted by the plan. If you don't need the money to finance college costs, you can leave it in your retirement plans to continue to grow for your retirement.