As we sit here today, I owe roughly $14,500 in student loans. Sounds like a lot, doesn’t it? Actually, it’s a paltry sum compared to the gargantuan amount of debt I racked up during my five and a half years in college and grad school – I did go to Duke, after all, where tuition expenses alone topped $40,000 this year. And although I was able to consolidate my student loans to a measly 1.25 percent, I’ll more than likely be writing a $140 check to American Education Services every month until I die. My father’s a financial professional, working as the CFO for a multi-state corporation with a hundred-million dollar operating budget – so why did I need to take out loans to pay for college in the first place? It comes down to a basic matter of priorities, and in my parents’ eyes, saving for college wasn’t one of them.
Instead of saving for college on my behalf, my parents chose to pool their investments into several retirement accounts. Saving for retirement – ensuring they wouldn’t be a financial burden during their retirement years – was a priority for my mom and dad.
The Case for Saving For College
These days, saving for college usually means opening up a 529 plan in your child’s name. Of course, Congress didn’t establish the 529 system – named for section 529 of the IRS code – until 1996, so my parents had far fewer options when it came to saving for college on my behalf (one being CDs, check CD Rates here). Today, 529 plans are the most popular type of college savings plan in the United States, and they come with a slew of benefits:
- Every state, as well as the District of Columbia, has at least one 529 college savings plan. Since all but five states give you a tax break for contributing to a plan based in your home state, this gives you flexibility to find a plan that works for you and your finances. However, you don’t have to invest in the 529 plan based in your state.
- Multiple people can contribute to the same 529 plan. For example, in lieu of birthday presents, you could ask your children’s grandparents, aunts and uncles to make a contribution to their 529 instead. New Jersey’s 529 plan comes with easy to fill out forms the donor can use to make a direct contribution to the beneficiary’s account.
- All investments grow tax free. As long as you use the contributions for qualified educational expenses, you can withdraw from the account without incurring taxes, similar to a Roth IRA account.
But the 529 also has its dark side:
- Say your son or daughter receives a scholarship for college and doesn’t need the money you’ve put into his or her 529 – then what? Your child has a decision to make: either he can change the name on the account for a new beneficiary, leave the account alone to use on future academic costs (there’s no age or time limit on 529 plans), or he can take the money out for non-qualified expenses and pay a 10 percent penalty.
- The amount of money saved in a 529 plan affects your child’s ability to qualify for financial aid. It increases your family’s estimated financial contribution, meaning if you have a large amount of money in your child’s 529, she’s less likely to qualify for grants.
- If you don’t chose a 529 plan based in your state, you may be forfeiting some of your tax breaks. For example, the state of North Carolina won’t give you a tax break on contributions made to a 529 held in Illinois.
The Case For Saving For Retirement
It was this dark side of saving for college that compelled my parents to making saving for retirement their priority. The most commonly held piece of advice regarding whether to invest in a college or a retirement savings plan is, “There are grants and loans to pay for your child’s education; no one is going to loan you money for your retirement.” Cliched? Yes. But, as my dad knew, it was also true.
- When I was growing up in the 80s and 90s, the economy was booming. On the first trading day of the 1980s, the Dow Jones Industrial Average closed at 824.57; by the time the new millennium dawned twenty years later, the Dow was above 11,000. When the government first introduced 401k plans in 1981, my father took advantage of his employer-sponsored plan. My father’s invested the maximum contribution – $17,000 for account holders under age 50 for the fiscal year 2012, plus another $5,000 a year for those over 50 – just about every year since.
- Not only did my dad’s employer sponsor a 401k plan, it also helped to fund it through a company match. For every dollar my dad invested into his 401k, his employer invested an additional $0.50, up to ten percent. While a matching program like this is relatively unheard of amid the economic recession – my dad’s company has scaled back its employer match to just $0.25 for every dollar invested by the employee up to six percent – it’s still free money.
- Colleges and universities cannot factor in your 401k, Roth or other qualified retirement accounts when your child applies for financial aid. This means money in those accounts is protected.
The Verdict: My Family’s Decision
Now that I’m a mother of two, I’m just hoping my children follow in my husband’s footsteps and go to college on an athletic scholarship… but I know that’s unlikely. While my parents’ approach to managing investments and saving for some of life’s biggest milestones – like retiring or college – is rather unique, it’s a philosophy I’ve come to embrace as well. Here’s what we do in my family:
- Whenever possible, my husband and I take advantage of his 401k match through his employer – it’s $0.25 on every dollar up to seven and a half percent of his income. In other words, we always try to put at least seven and a half percent of his gross income into his employer-sponsored plan in order to take maximum advantage of the benefit.
- We try (“try” being the operative word) to max out our 401k contributions to the yearly limits set by the federal government.
- After our daughter was born, we opened a 529 account in her name, but we don’t fund it unless we’ve already reached the maximum contribution limit allowed by law on our retirement accounts. This has only happened once in her three years of life. Instead, most of the money in her 529 – and in the one we opened for her little brother last year – comes from family and friends who send the kids money for their birthdays, which we invest on their behalf.
Managing investments is never a one-size-fits-all approach, and my family’s decision may not work for you.
What is your family’s approach to saving for retirement vs. saving for college?