For many parents, balancing the funding of higher education for their children while also securing a comfortable retirement for themselves can feel like a daunting task. Luckily, with careful financial planning you can create a strategy that works for everyone—allowing you to support your children in the face of rising college costs, without compromising your retirement goals.
The Rising Cost of College Education
College tuitions are steadily increasing, with no current indication of slowing down. The requirements can place a significant financial burden on families. From 2000 to 2021, the average cost of college jumped a notable 69%, with that number only taking tuition and fees into account. Meanwhile, the cost of living across the country has also risen, making typical expenses that college students deal with—groceries, gas and transportation, etc.—an added stressor.
What Goes Into College Expenses?
From tuition to textbooks, the financial landscape of education has changed. Understanding these components is critical to implementing a series of financial strategies that will align with your goals.
Schools are increasing prices to cover expenses like administration costs, improved on-campus amenities for students, competitive pay for faculty, and bolstering the academic and sports programs that attract students. While some of these aspects do add to a student’s overall quality of experience, the financial responsibility students and their families are dealing with may not feel balanced in comparison.
When Retirement Savings Takes a Backseat
When faced with competing financial priorities, many parents instinctively choose their kids over themselves. Contributing to a child’s college payments, or funding them entirely, may feel like something you’re obligated to do—especially as it becomes more commonplace for families to cover at least a portion of their child’s college expenses. In fact, close to 87% of families paid for a percentage of their child’s college bills in 2022.
Parents will often look at the big picture financial goals they have on their plate and work together to figure out what can take a backseat. More often than not, retirement savings is one of the first things to get reduced or paused when parents are trying to determine how to access funding to send their kids to a college or university.
The Problem With “Pausing” Retirement Plans
If you are considering putting a temporary stop on boosting your retirement nest egg, it’s important to know the potential consequences of that decision. When you’re saving for retirement, you’re taking advantage of compound interest to help your savings grow over time. Eventually, between regular contributions and compound interest, the strategy is to have a portfolio that grows enough to fully support your retirement lifestyle.
In an immediate sense, it may seem like adjusting retirement savings contributions in order to pay for higher education isn’t a big decision—it’s only four years of re-allocating cash flow, and supporting your children by allowing them to graduate debt-free seems worth it, right?
Potentially not. If you actually consider the monetary implications, you may discover that enacting a temporary “pause” or reduction in contributions could have a dire impact on your retirement savings.
Let’s say you have $40,000 currently tucked away in your company 401(k). You were planning to get close to maxing it out each year—contributing $19,000 annually. With an estimated 6% rate of return, your total balance would grow to $134,144 over four years.
Source: Compound Interest Calculator, NerdWallet. https://www.nerdwallet.com/calculator/compound-interest-calculator
However, if you stopped contributing altogether, and let your $40,000 balance simply sit for four years, you’d only hit $50,819 by the end of your child’s college career. A modest increase in comparison to Example One.
Source: Compound Interest Calculator, NerdWallet. https://www.nerdwallet.com/calculator/compound-interest-calculator
Alternatively, as shown in Example One, the funds you continued to contribute would exponentially grow over time. Compound interest works like rolling a snowball down a hill: the more it picks up with each revolution, the more it grows. By taking a four-year “break” from contributing, you could leave yourself at a marked disadvantage when you reach retirement.
The Pros (And Mostly Cons) of Pulling From Retirement to Pay For School
Another option many parents explore, even if they plan to continue contributing to their retirement savings, is taking a loan from their 401(k) or other retirement account to cover initial costs. Parents do this for a few reasons:
- 401(k) loans don’t require an excellent credit score.
- There are no fees associated with 401(k) loans.
- Often, interest rates on 401(k) loans are lower than traditional loans and/or student loans.
That being said, pulling from your 401(k) also has several drawbacks to consider:
- The loan has to be repaid within five years, meaning it’s unlikely your child will pay you back before it’s due. Realistically they’ll still be in school, or just newly graduated.
- You may not be able to make pre-tax contributions to your 401(k) until the funds are repaid.
- If you are laid off or fired, you typically only have 60 days to repay the funds to your 401(k).
- The loan will still have the same negative impact on your lifelong nest egg balance, and you’ll lose out on years of compound interest you’d otherwise be collecting for those funds.
Thus, although it’s perhaps appealing as an option, the consequences typically outweigh the benefits in this situation.
Striking a Balance
There are alternatives to fully funding your child’s college experience without sacrificing your own financial future and lifestyle. The first step is to strategically plan ahead for college costs, and to get a clear idea of what you’ll owe.
Planning for College Costs
- Set a realistic budget. Before your child even starts applying for colleges or universities, it’s helpful to set a clear budget for them to stick to. The budget might be what you can afford to help with, or how many loans they’re comfortable taking on. This is also a good opportunity to better understand what your Expected Family Contribution (EFC) will be, and what type of aid you might qualify for.
- Do your research. Knowing what different schools cost can create a great foundation to work from. Look at in- and out-of-state, private and public schools, and perhaps even community colleges. Research what programs your child might be interested in, and what costs are associated with their chosen field of study.
- Look at all sources of funding. Federal funding is typically the top source of college scholarships you’ll receive. However, be open to private scholarships, or merit and need-based scholarships at specific schools.
- Don’t be afraid to talk to family members. Does your high school student really need (or want) an arbitrary birthday gift they may or may not use? Consider asking family and friends for contributions to their 529 Plan in lieu of gifts. If they’re especially set on attending a specific school, every dollar counts.
- Leverage 529 Plans and/or Roth IRAs. Speaking of 529 Plans: you can leverage different investment vehicles to grow your college savings “bucket.” This might include a 529 Plan, or even a Roth IRA if your child has an earned income.
- Consider alternative education options. A community college to reduce your child’s costs for their first few years may make sense. They may also look at a trade school or other form of secondary education to get into the field they’re passionate about.
Stay Consistent With Retirement Savings
To stay consistent with retirement savings during this season, there are a few options available to you:
- Reduce, don’t halt, contributions. If you truly need to free up cash flow, find a happy medium. This may look like reducing your contributions each paycheck, but committing to staying consistent for all four years your child is in school.
- Increase earnings. When you’re faced with a situation where more cash flow is needed, it may be a good time to increase your take home pay. You can ask for a salary increase, go after a promotion, or pursue a new avenue in your career that comes with a pay increase.
- Side hustle. If you or your child has spare time, finding a side hustle to earn increased income may be helpful during this season. Some parents of college students pick up drop shipping, open an Etsy shop, or make themselves available for freelance or consulting work.
Other Ways to Support Your Kids
Covering the full college bill isn’t the only way you can support your kids during their higher education years. Setting them up for long-term financial success can look like:
- Talking about budget and goals. Having your children accumulate credit card debt in the midst of working hard to allow them to graduate without student loans defeats the purpose. Make sure they have a clear understanding of finances and how to set a budget for themselves.
- Pick the right school. Set them up for financial success by helping them vet different colleges (and their associated costs). For students, navigating the college application and decision process can be confusing and emotional. Be their guide and confidante to help them make the decision that will serve them both now, and in the future.
- Explore career options. Help your child think about what they want to do after graduating college, and research what income those positions make. This can help them better balance the cost of college—and their spending habits—with future expectations.
- Discuss loans. Realistically, many students will need to take out student loans, and these loans do exist for a reason. Remember, there’s no “retirement loan” you and your spouse can apply for later on if you’re financially compromised. In other words, teaching your kids to navigate a debt they’ll have years to repay may be better than shorting yourself valuable savings. Not to mention potentially needing your children to help take care of you later in life because you under-saved.
Remember, Open Communication and Planning Are Key
When it comes to balancing college and retirement, there is no one-size-fits-all answer. Keeping an open line of communication with your kids about expectations, budget, and what’s best for the entire family is key. Often, having a financial advisor help you manage those conversations and create a game plan can be invaluable. If you have questions about navigating the college tuition funding process or figuring out how to make a plan that sets you and your children up for success, reach out to us. We’re always here to help you and your family create a strong plan for a brighter future.
Sources:
Bryant, Jessica. “Cost of College over Time: BestColleges.” Best Colleges, 30 Jan. 2024
Schoeff Jr, Mark.“College costs can sink parents, too” Investment News. 04, April 2019
McCormak, Kayla. “What Percentage of Parents Pay for College?” SoFi. 20, July 2023
