Should you delay contributing to a retirement plan to help your kids fund college?
Imagine you’re at the hospital and your wife has just given birth to your first child—a perfect baby girl. Friends and family are coming to visit. They all want to hold your baby, shower her with gifts, and relieve some of that baby fever. Perhaps some of your more practical family members even give you money to set up her college fund.
With a small college fund officially started, it’s time to ask yourselves the tough questions. How will we continue to fund for college? What about retirement? What’s the next step? What’s the priority?
It’s easy to get lost while searching for the answers. Money can be tight. There’s the mortgage to pay. There are added insurance costs, too. An emergency fund is needed for unexpected expenses, and on top of it all, expenses have increased with your new family member. It all adds up and sometimes there isn’t enough room in the budget for everything. Saving for college and saving for retirement tend to be afterthoughts.
Is saving for retirement more important than funding college for your kids?
Some parents might be tempted to follow advice that prioritizes saving for college over retirement because “there will always be time” to save for retirement later. Fortunately, most financial experts generally recommend saving for retirement first and saving for college expenses second.
Why? For many reasons. For starters, you can always borrow for college but you can’t borrow for retirement. And unforeseen events, like a forced early retirement, may leave parents wholly dependent on Social Security checks to fund their lifestyle.
Plus, colleges offer a myriad of ways to pay for tuition. There are grants, scholarships, and work study opportunities, in addition to student loans. All of these allow students to help fund their education without significant contributions from parents.
While it might seem noble to want to help your children achieve a college education under the guise that it will lead them to a better and more fulfilling life, neglecting your own financial well-being at the expense of your children achieving that goal could be harmful for both. With your own retirement future secure, you are in a better position to help the kids as they transition into adulthood.
How compounding affects retirement savings
The biggest factor influencing the size of retirement savings is time. Time is your friend in allowing your retirement savings to grow. The more time you give them, the more time the power of compounding has to work its magic.
To illustrate this magic let’s look at two sets of parents. One makes retirement a priority and the other makes college the priority before saving for retirement. The first couple (Couple 1) invests $5,000 per year for 10 years from ages 25 to 35. The second couple (Couple 2) invests $5,000 per year for 30 years from ages 35 to 65.
Our first couple only put away $50,000 for retirement while the second couple saved $150,000 and still came up short in comparison. This is a perfect illustration of why saving for retirement should come first and saving for college should become a second priority.
The power of compounding allows your earnings to grow ever faster much as a snowball grows as it rolls further and further downhill. As you can see in our illustration, our second couple cannot catch up with the first couple even though they saved an extra $100,000 and saved for an additional 20 years.
Saving for the kid’s college may be a noble endeavor and something every parent may aspire to do. But as our example shows, taking care of retirement first will pay dividends for years and years to come.
Kent Wright – Due Diligence and De-accumulation Analyst – firstname.lastname@example.org – 800.236.7400 Ext. 3252
Kent is a subject matter expert on 401(k), retirement accounts, investments, and financial services. Kent is also a published author.