Save for Retirement and Still Pay Your Kids’ College Costs

BY IVORY JOHNSON, CNBC

 

 

 

You can borrow money for a college education but not for your retirement. It’s what we, as financial experts, truly believe. But a constant tug-of-war between 401(k) plans and Section 529 college savings plans has ensued in investors’ hearts and minds—and neither side appears to be winning. Identifying priorities is no easy task. Just ask an average parent if his or her retirement is more important than paying for a child’s education.

Most parents are aware that over the course of an adult’s working life, high school graduates can expect, on average, to earn $1 million less than those with a bachelor’s degree and are 50 percent more likely to be unemployed. So it isn’t hard to see why parents might be tempted to make paying for their kids’ college education a priority over saving for their own retirement.

At the same time, college costs have, according to published reports, increased 1,225 percent since 1978 (that is not a typo)—more than housing, food or health-care expenses. Penn State cost my parents $7,500 a year, but I will be on the hook for almost $40,000 a year if my son goes to the same school. (It hurts me just to write that sentence.)

As a consequence, parents who are willing to provide a more lucrative future for their children do so at the expense of their own. It should be no surprise, therefore, that 57 percent of U.S. workers have less than $25,000 in savings. Meanwhile, student debt has reached $1.2 trillion, growing seven times faster than this country’s mortgage debt in just the past 10 years.

So what to do? A flexible game plan might be the best option.

Sure, the 529 plan allows parents to save money in a tax-deferred account with no taxes on distributions if used for qualified education expenses, but why not manufacture a similar outcome with a retirement vehicle? In other words, here is a chance to kill two birds with one stone.

For example, a Roth individual retirement account offers tax-deferred growth and tax-free distributions, a winning combination for anyone trying to save for retirement. Should the account holder choose to use that money for a child’s education, they might be in luck. Contributions made to a Roth IRA can be withdrawn tax-free if used for a qualified education expense.

Moreover, the Roth IRA will treat those distributions on a “return of contributions first and earnings second” basis. In other words, a $5,000-a-year contribution for 10 years would allow a parent to withdraw $50,000 for college tax-free and leave the earnings in the same account to be used during retirement.

Most households depend on a 401(k) plan to save for retirement on the grounds that they receive a tax deduction today and pay ordinary income taxes when they take distributions later, presumably when they are in a lower tax bracket. I suspect, however, that if somebody offered to lend me money without disclosing the interest rate or any of the terms, I would decline the invitation.

That is exactly what a 401(k) plan is, a tax-deferred contribution today in exchange for the expectation that tax rates will be lower when 70 million baby boomers are receiving their entitlement benefits. Furthermore, a hardship distribution from a 401(k) to pay for education is still subject to the 10 percent early withdrawal penalty for those younger than 59½, and that is on top of ordinary income taxes.

Another option to consider is cash-value life insurance to plan for both objectives. Should the policy offer attractive guaranteed rates of return, over time the cash value will grow to a reasonable level without being subject to market volatility or capital gains taxes. When it is time for either college or retirement, the policy holder can borrow money from the cash value and pay it back with the death benefit when they die.

Please note that when you borrow money from a life insurance policy, it doesn’t show up as income and has no impact on financial aid or the tax rate on Social Security benefits. These policies are known to have high expenses but may offer steady returns, tax-deferred growth and no exposure to income taxes in the future.

There are several strategies that can address the same goal, so find one that lets you sleep at night. If you are comfortable working longer in exchange for your child’s education, then own it. List it as a priority, write it down, and don’t second-guess the decision later. The only reason anyone ever gets upset is because their expectations aren’t met. Our life is the sum total of the choices we make, so it is about what is important and what we can live without.

When it comes to retirement vs. education, choose wisely, make a plan, stick to it, and avoid that tug-of-war.

H/T Source: The Fiscal Times

Turn Retirement Dreams into Reality

Have dreams about retiring early? We have some tips on how to make that dream a reality.

According to the Michigan Association of CPAs, retiring early takes meticulous planning and more than a tidy sum of money, but for the truly committed, early retirement is possible. Here is what you need to do if you desire an early escape from the work world.

Envision Your Retirement Years—One of the biggest challenges that retirees face is determining how much they need to save by the time they hope to retire. The further away you are from retirement, the more difficult the task. CPAs and other experts say you need somewhere between 70% and 80% of your pre-retirement income to maintain your standard of living. This rule of thumb is helpful for starters, but it doesn’t consider that the amount of money you’ll need in future years depends, to a great extent, on the retirement lifestyle you plan to lead.

Make The Most of Retirement Savings Opportunities — Perhaps the best way to prepare for an early retirement is by taking full advantage of 401(k) plans or other employer-sponsored, tax-deferred retirement plans. These plans make it possible for you to invest pretax money for retirement directly from your paycheck and, as an added bonus, many companies will match part, or even all, of your contributions.

If you’re self-employed, you can create your own retirement plan by opening a Keogh account. Even if you work for another company and are covered by a retirement plan, you can use a Keogh plan to shelter self-employment income you may earn from consulting or freelance work.

Traditional and Roth IRAs offer additional opportunities to build your retirement nest egg. Eligible workers can contribute to an IRA even if covered by a 401(k) at work. In certain cases, your IRA contribution may be tax deductible and, in all cases, there is no tax on earnings inside an IRA until the money is withdrawn.

Reduce Expenses to Build a Surplus — Retiring early is an aggressive act that requires not only intense saving, but a serious willingness to live below your means during the wealth accumulation phase of your life. Are you willing to replace expensive restaurant meals with dinners at home? Are you ready to lower your housing costs by trading down to a smaller home? The more fat you can trim from your budget, the more you can invest toward achieving early retirement.

Become an Astute Investor — It’s important to be vigilant about the allocation of the assets in your investment account. The biggest mistake you can make with retirement savings is to play it too safe. The longer you have before you retire, the more you should invest in stocks which offer growth potential. Stocks may be considered risky because they are more volatile in the short term but, over time, stocks typically outperform other investments. Your challenge is to achieve a reasonable balance between risk and reward.

Consider Your Future Insurance Needs — Right now, you probably have health, disability, and life insurance coverage under your employer’s group policy. In fact, your employer probably pays some of the cost of this coverage. When you retire, at the very least, you will need to replace your health insurance with a new policy that will carry you to age 65 when Medicare kicks in.

Enlist Help — Retiring early necessitates far more than a desire to call it quits before reaching your normal retirement age. It requires a knowledgeable look at the lifestyle you envision and the resources you have to fund your future. A CPA can be a valuable resource for would-be early retirees. He or she can help you work out a spending and investment plan that considers your retirement goals, current resources and investments, and future sources of income, as well as taxes, inflation, interest rates, and other components that factor into your plan. The sooner you make an appointment with your CPA, the sooner you’ll be on your way to achieving early retirement.

This article was submitted by the Michigan Association of CPAs.