Retirement or Education?

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Chris writes in:

We are friends with another couple that is around our same age, income level, status, and number and age of children. When I was mentioning to them that we were planning to pay off our car this year (leaving us with our mortgage and a small student loan) and the starting to put $50 to $100 per into 529s for each of our kids (currently aged 1 and 3), she mentioned that they were not starting 529s, but rather had a different philosophy….. They were going to contribute up to the company match in the 401K, max out a roth IRA (every year) and then pay off their house in 15 years, which would be just when their oldest is about to start college. Then they would use any excess from their income (that was now free because they no longer had a mortgage) in order to help with their child’s education. She also mentioned that she did not believe that her children would qualify for much (if any) financial aid. This would be the case for us as well. We are currently putting approximately 10% into our 401K and we plan to put approximately $3,000 per ear into a Roth IRA starting this year. Can you comment on what might be the pros and cons of either financial philosophy? I suppose that I should also mention that I do not forsee us having any issues with having enough $ for retirement and my philosophy is that I would like to contribute to 25-33% of my children’s college costs.

First things first: with all things being equal, you’re better off putting your money into retirement savings than into college savings. There are several reasons for this.

First, your children can make college happen even if you don’t have a dime saved for them. Between student loans, scholarships, and other aid, most students who are accepted to a school will be able to find some way to go there. They may end up with a lot of student loans in the process, but it won’t prevent them from getting an education.

On the other hand, you can’t make up for missed retirement savings. Nothing can undo missing the early years of your retirement plan, because those are the years when compound interest is at its most powerful. The money you put away right now will be much more valuable than any money you put away in your 50s or 60s.

Another factor to consider is that many retirement plans allow you to “borrow” against them for educational expenses. You can withdraw some amount, agree to a repayment schedule, and use that withdrawn money to help pay for your children’s college education.

A final note: if you haven’t saved adequately for college, you may end up being a financial burden for your children late in life. You might not ever ask them for money, but they’ll see that you don’t have much money and will stretch their wallets to help you when they can. I have seen this many, many times.

In short, if you’re unsure, I recommend saving for your retirement over saving for your child’s education.

The next question, then, is why should one ever save for their children’s educational expenses?

We’re saving for that purpose. That’s because we have plenty of money to save at this point – our retirement savings are fully covered, plus we have extra money beyond that to push towards long term goals. One of those long term goals (for us) is to pay for some significant portion of our children’s college education. After doing the math, we decided that saving $100 per month for each child from the day they were born to the day they leave for college is the best bet.

In other words, if you can save for college without short-changing your retirement, go for it.

What about that third factor, though? Where does paying off your house rank?

When it comes to using your home as an asset for college savings, you’re betting on two things. First, you’re betting that the payments you make on your home mortgage are more financially efficient than money socked away in your 529. If your mortgage interest rate is 6%, then your money channeled into that is effectively earning a 6% return. If you put that amount in a 529 instead, you could earn more or less than 6%, depending on your investment choices and the risk you’re willing to take on.

The second (and more challenging) bet comes later, when you want to tap your home equity. You’re betting on the interest rates at that future date, because your loan will charge you some interest rate. Will you need the money at a time like today, where the Federal Reserve is keeping rates low? Or will you need it at a more challenging time, when interest rates are higher?

If saving for college is important to you and your family, I would probably do things in this order: retirement savings, then college savings, then mortgage.

One final note: I would never rely on future earnings to pay for college education. Our lives are far, far too uncertain to bank on your professional income in fifteen years as a source for college savings – or savings of any type. People radically change careers. People are downsized. People are disabled. People stumble into great opportunities. These things happen all the time. To bet on stability there would be the biggest gamble of all.

Good luck.

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72 thoughts on “Retirement or Education?

  1. It was never stated that the second couple would use equity from the house to pay for college. That was a bit of leap.

  2. I hope not saving for college does not make parents a burden on their children, I’m assuming you meant retirement?

  3. You missed an important part of the calculation for comparing paying off a mortgage to investing. The interest on mortgage payments is tax deductible. If you’re in a 25% tax bracket then the money funneling towards the mortgage is only earning 4.5%, not 6%. So if you believe you’ll earn more than 4.5% elsewhere it makes more sense to do something else with you money than accelerate paying off the mortgage.

  4. I assume it’s a typo (but a pretty big one) and you don’t mean to say “if you haven’t saved adequately for college, you may end up being a financial burden for your children late in life”

  5. I graduated without student loans, and I can’t tell you how positive an impact that had on me psychologically. Because I was given a debt-free life, there was no way I was going to mess that up and start wracking up credit card debt or any other sort of debt. I know that student loans, on the whole, are relatively “good” debt. But for me, not having loans set up a completely different lifestyle. I completely agree that unfunded retirement accounts are more alarming than an unfunded education. I just really hope everyone strives to fund both. I know I am.

    Just as you’re skeptical of relying on future income to pay for college, I’m skeptical of how good a handle we have on college costs 10 or 20 years down the line. The top schools already give their in-need students a full ride. Is that a trend that’s going to continue or reverse? State schools (that used to give free rides for good students) are retrenching. If you asked me to give a range that I thought costs were going to be in in 2050 and asked me to be 95% sure of my guess, I’d probably come up with something like “between $0 and $500,000 per year”.

  6. I had a MET back when they were worth something, and between that and scholarships got basically a full ride. I see no reason not to use a Roth as a college investment vehicle, you can withdraw the principal at any time, so stick your money in now when young and compound interest works its magic, and then you can take out whatever you cant pay out of pocket later if necessary. At 25 I dont have kids yet, but I can already start saving for their education this way, and if we decide on no kids, its just bonus retirement.

  7. “A final note: if you haven’t saved adequately for college, you may end up being a financial burden for your children late in life.”

    I assume you meant, ” . . . saved adequately for RETIREMENT, . . .”

    Yes?

  8. Isn’t there a special ESA (education savings account) where you can save toward your children’s educations tax-free? I think even if it’s only $20 a month set aside for education, it’s better than nothing.
    Also, if saving for education isn’t an option for the parents, they should at least teach the children to save for it themselves and that loans aren’t always necessary. Being a recently graduated student myself, I wish that my parents had taught me something like that. Luckily, my husband’s and my student loans are nearly paid off, but I would have much rather graduated debt free, using that same money to save towards the purchase of a house.

  9. “Then they would use any excess from their income (that was now free because they no longer had a mortgage) in order to help with their child’s education.”

    Implies that they won’t be tapping the equity in their house, but instead anticipate using the cash that has been freed up from paying the mortgage to help pay for the child’s education. This makes sense to me, because if things change in their live, they can cut back on the payments to the kids.

    I believe strongly in paying down on ones house quickly because that gives you a lot of flexibility in the future by reducing your fixed costs and helps combat lifestyle inflation in the present.

  10. “I would never rely on future earnings to pay for college education.”

    Unless you have enough money in the bank right now to pay for college for all your present and future children, you need to rely on *somebody’s* future earnings (yours or your children’s, and counting scholarship as a type of earnings). So I don’t understand what you’re getting at here.

  11. Another consideration (from one whose child has graduated college already) is that during the financial aid decision, colleges generally assume only a percentage of the parents/family income/assets are available to go toward college costs (depends on size of family etc), but that any savings the child has are considered 100% available for the time they’ll be in college – so essentially 25% each year of any college savings will be used up. So we built up our personal savings rather than putting a whole lot into our child’s name – that way she qualified for larger scholarships & grants from the college, & once college was over, we still had $ available to use if needed to help her while job searching.

  12. As one who just finished putting two kids through college, I can tell you that I wish we had invested in a 529 that locked in college tuition at the rate it was when our kids were younger. When I started a state college, tuition was $7 per hour. Yes, $7. When I transferred to a private college, it was $28 per hour. When my oldest started state college, it was $72 per hour and my youngest started private college at $700 per hour. Who knows how much it’s going to go up in another 18 years. I doubt if many people whose mortgage payment can keep up with that kind of inflation.

  13. It doesn’t have to be an all or nothing either. It can be about helping your child have some options. You don’t have to sock away the full tuition. I’m of the mind the kid should work for school at some level to appreciate their education. So I’ve never promised more to my kids than two years at a community college and two years at a state school they could drive to locally. They want more, they find a way to pay for more.

    I started with twenty dollars a pay check and raised it five bucks a little more than once a year or so when I got a raise or cost of living increase. It’s working out to end up being around thirty thousand a child total for college (assuming I continue the savings through all four years of college). It meets my promise without really affecting my past and current lifestyle. Where you save it (Roth, 529, etc.) is less relevant than you save something if you’re comfortable with your retirement savings.

    Also, if my eldest finishes school at the current rate I may be inclined to assist with loan repayment since the loans are not going to be that huge. I can also take some or all of what I was routinely saving and help with potential increased costs for the next child.

    That’s the value of having money you’re consistently saving for a purpose that goes away at some point. You can shift the purpose without affecting your current lifestyle and help where it’s needed. Kind of like a savings snowball instead of a debt snowball.

  14. You say that paying of a mortgage that has a 6% interest rate will effectively earn you 6%. That is 6% AFTER tax. You would have to make almost 9% in the market to beat that level of return if you are in a 30% tax bracket. Most people people jare hardpressed to get a return of 9% in the market these days.

  15. I loved that my parents paid for my college education but because they were willing to do that all along I felt pressured. I would like my children to have a passion for going to school and go for what they like. I’d be willing to pay for some of my child’s college but would have them pay for the other portion either from pursuing scholarships or working for their goals.

  16. I completely agree with paying off a house and counting on future income to pay for college before saving for a child’s education while keeping mortgage debt.

    Trent’s view: “I would never rely on future earnings to pay for college education. Our lives are far, far too uncertain to bank on your professional income in fifteen years as a source for college savings – or savings of any type”. Our lives being uncertain is exactly the reason to pay down your mortgage before funding education. If you do have a problem with money in 15 years, due to a disability or medical issue for example, wouldn’t you rather have your house paid for and know you are not going to lose your house vs. losing your house but your child has their college paid for?

    I plan on paying almost 100% of my 4 children’s college, but have not saved a dime for it. We are in our early 40′s, make $130K combined (i work P/T), have $200k in 401K and are 1.5 years to being mortgage free. We pay about $37K towards mortgage each year. My oldest is in 9th grade and the plan is to pay off mortgage and start saving that $35K towards college.

    If something dire happens to our financial situation in the next 5-10 years due to disability, medical issues, etc. and we are not able to fully fund our children’s education as planned, I will rest knowing that we do not have to worry about paying a mortgage every month.

    I understand everyone has different viewpoints but my view is that the priorities should be: retirement, completely debt free and then children’s education.

  17. My kids will be going to college much sooner, and I’ve starting looking at financial aid requirements. I noticed that home equity and retirement accounts aren’t considered as part of parental assets so fully funding those could be a great strategy to make sure that the kids qualify for financial aid, if they need it.

    Of course, as readers pointed out, things may change dramatically by the time the kids are ready to go to college. In fact, the tax laws have changed multiple times, 529s were introduced, for example, since my kids are born.

    But it makes sense to me to fund retirement accounts and pay off the mortgage. The value of those actions doesn’t seem to have changed over the years.

  18. My kids will be going to college much sooner, and I’ve starting looking at financial aid requirements. I noticed that home equity and retirement accounts aren’t considered as part of parental assets so fully funding those could be a great strategy to make sure that the kids qualify for financial aid, if they need it.

    Of course, as readers pointed out, things may change dramatically by the time the kids are ready to go to college. In fact, the tax laws have changed multiple times, 529s were introduced, for example, since my kids were born.

    But it makes sense to me to fund retirement accounts and pay off the mortgage. The value of those actions doesn’t seem to have changed over the years.

  19. Here is an interesting side to this, would it make sense to (assuming you are under limits) contribute to retirement now and then when they graduate help repay loans? Seems like with the way financial aid and federal student loan rates and what not, it is a better decision.

  20. Also, Chris’s question doesn’t have anything to do with whether parents should help pay for their children’s educations or not. And, as Greg mentioned, it doesn’t have anything to do with tapping home equity to pay for college. So I kind of don’t understand what you’re getting at with this whole article.

    If you’re going to write articles based on reader questions, then you should at least try to answer the question that was asked. If you’re just using the reader questions as jumping-off points to write about whatever you would have written about anyway, then why bother including the questions?

  21. My parents paid for the vast majority of my private university education, but they still expected me to do work study and take a few thousand dollars in student loans each year. I think that was a good idea, especially because my university was really expensive. I don’t believe that either of my siblings had to pay anything towards their education, but they went to state schools. I think we will do the same for my children, except we will probably pay for a full ride at whatever major state school is nearby. (this is of course is barring any health problems or other unforeseen problems that would affect our finances). If they want to go somewhere more expensive, they have to pay the difference.

    I thought long and hard about the 529s and decided that the Roth IRA option made more sense. If we save $5,000 a year in each of our Roth accounts, that should be plenty for two children. Now if we decide to have three, we might have to rethink matters!

  22. This isn’t really an “OR” question, it’s an “AND” question. How do you fund your retirement AND pay for college?

    In terms of paying for college, you don’t need to have the entire amount available at Day 1, since getting an undergraduate degree takes four years. So you could save up some money, then pay for some tuition out of the monthly budget, and also have the child contribute some money, as well.

    It’s also not unreasonable to have conversations with your kid about what to expect for college funding from you when they are in high school. Your kid might think you are made of money and will be funding the best six years of their life, while you might be thinking you’ll pay half of state school tuition and they’ll work a summer job and work study to get the rest. Put it on the table so they don’t get a rude awakening in their senior year of high school.

    College funding is also an excellent reason why kids should be a part of family budgeting and money management at an early age. Parents are the most influential figures in a child’s life, and knowing about finances is one of the most valuable lessons that can be taught.

  23. My husband and I are making a huge assumption that out children will even go to college. We are putting a small amt into a 529 and Coverdell for them but then also save money separately in a savings account (in our name). If they don’t go to college then it would suck to pay a penalty and taxes on the money if it was all in a 529/Coverdell. I like the idea of saving in a Roth because you can use it for your own retirement if they don’t go to college or if they don’t need it. Because of a fluky year, we didn’t qualify to put money in a Roth this past year, but we will start ramping up the contributions in 2010 with the intention of also using that for college if need be.

  24. A few things – I would think that the kids would be expected to have at least part-time jobs while in college, to help pay for some expenses. Also, there are THOUSANDS of scholarships from a wide variety of organizations that don’t have financial requirements. You can also ensure that your child qualifies for whatever financial aid is available by never claiming them as a dependent on your own taxes as soon as they’re 18. And, as others have mentioned, what if your kids choose not to go to college – what happens to the 529 then?

    I have worked in higher education for over 10 years, and I am here to tell you that tuition is the next bubble. Tuition has been rising faster than inflation for some time now, and because of the recent financial/economic crisis leading states to cut back so much on public institutions, lots of universities all over the country are going to raise tuition for the next academic year between 25-33%. This is because we didn’t really resolve what happened with housing, we just pushed the debt around and now it’s going to come out somewhere else.

    Probably all of this will be resolved by the time Trent’s children (and anyone with young children) is ready to go to college. But if you have high-school-aged kids now, then I would NOT encourage them to go to college right away unless at least 2/3 of their education is funded through grants and scholarships. You should NOT be borrowing money right now to pay for college or even, to be honest, using money you have saved up unless you really will not miss it at all, because you will be buying at the top of the market.

    OTOH, I predict that many universities will fail when the tuition bubble bursts, so maybe you want to get your education while you still can. Despite the fact that it is public universities that are going to start exhibiting problems first (because they rely on state dollars to run), it is the private universities that are probably going to go under because once their endowments are gone, there is noplace for the money to come from. But then again, maybe the private universities will become a bargain once tuition rates at public institutions surpass theirs and they’ll do great. There’s a lot to consider.

    But I can almost guarantee that within 10 years there will be a HUGE, devastating meltdown of higher education in the U.S.

  25. I think those friends have a good plan. They are still planning on paying for their child’s education, and without tapping home equity. But if their child decides not to go to college, they also have a paid for home, rather than an account full of money they can’t tap without penalty. I guess it comes down to which is more of a gamble: that the parents will remain employed or that the child will choose not to go to college?

  26. I think the second option does a better job of covering the parents regardless of what their kids decide to do.

    I agree with Honey that tuition NOW is greatly inflated and that it’s likely to just get worse.

    Frankly the best “insurance” you can have in terms of paying for your kids’ higher education is to make sure they do well in high school. They’re not going to get scholarships if they have a “C” average, bad language skills, or a bad attitude.

    For those whose kids are under ten: fill your house with books, turn off the TV, talk about current events with them, include them in conversation with your adult friends and teach them how to behave among adults, do learning activities with them like gardening or home improvement. This will all, ultimately, contribute just as much as (or more than) financial support to their academic success.

    Kids used to be put to work at six or seven; they’re capable of a lot more than our culture has grown to assume. One of the problems with the US system is we don’t start training kids to be productive citizens until they’re in college, which is a little late.

  27. Honey, I’m graduating this year. If I don’t go to college, what should I do? A retail job is only going to pay minmum wage and I am, like most high school students, unable to get a “real job” without a degree or certification.

    Delaying undergrad seems like a dangerous mistake.

  28. @Honey, #18. Claiming your child as a dependent has very, very little to do with how much financial aid they get. The FAFSA has a section with 6 questions, and if you can’t answer yes to one or more of them you are considered a dependent student. And “do your parents claim you as a dependent on their taxes?” is not one of them. All of them have to do with life circumstances, are you married, a veteran, have dependent children, legally emancipated, over 26, etc. If you can answer yes to one or more then you are an independent student, and you have a lot more options available.

  29. Education is NEVER a bad investment. Never. Spending a few years studying for a degree will increase your lifetime earnings significantly, and will enrich your life and your mind. I never have a problem with education, no matter the cost.

  30. The friends have a solid plan. Houses are generally exempted from financial aid decisions. While they feel that they are not likely to qualify, you never know what happens with future income. The smart thing to do would be to nab a low interest rate HELOC sometime when their kids are less than 10 years from school (typically there is a 10 year drawdown period). They aren’t going to use the HELOC but if they get in a jam, they can tap it. They can pay down their mortgage as aggressively as they can and if their free cash after that paydown allows them to fund the school then they never need to tap the HELOC. If it turns out they can’t afford as much as they want to pay, they can tap the HELOC a little to smooth out the time when the kids are in school. The beauty of paying down the mortgage is that you have a guaranteed return and it keeps you from spending money on stuff you don’t need.

    What they want to pay for school, how much student loans, etc is all up to them.

    I’m not a huge fan of 529s due to the fees associated with them and the investment options. Over a 10 year period, you are looking at fees totaling 7 to 15% of the investment, which is crazy. Now you know why the financial industry loves them. Compare that to a buy and hold index fund like Vanguard’s S&P 500 where you might pay $100 over 10 years. Sure, you have the potential tax breaks but over an 15 to 20 year period, you give it all back in fees. A couple states like Louisiana have low cost options, but many states have plans with exorbitant fees.

    My Rec: Fund Retirement fully (beyond match), pay down mortgage w/Heloc hedge, invest in low cost index funds, and if you can find a very low cost 529 plan stash some money in that too.

  31. I’m still not clear what to prioritize after a) emergency savings and b) retirement savings are put in place. If I have an extra 100-200 a month left over, should I put it towards the mortgage to pay it off early possibly in time for kids graduating from HS, or put it in college savings funds? I can see pros and cons with both. There is also the c) option of instead of putting in college fund, put it in Roth IRAs. Still confused.

  32. @ Ryan #21, College isn’t the only way of life, millions of Americans make lots of money doing skilled labor. I have friends who made more at 18, fresh out of college, than my 2 college educated parents did at 45 COMBINED. I will never assume my children will want to or force them to attend college.

    I had savings bonds from every birthday & Christmas since I was born that I was allowed to cash in to pay for college, everything else was Financial Aid, Scholarships or working to pay for college. I came out with about $10,000 of student loans and a great resume of work experience. I am thankful my parents required me to earn my degree both in education and financial ways. I found that even as a freshman I took my classes more serious than my fellow students. I knew that each class was $300 plus books out of my pocket, and that my success/failure was my own.

  33. @Ryan, I never said that people shouldn’t go to college. I said they shouldn’t borrow money to go. If you are a senior in HS now, there are several recommendations I would make: only apply to institutions in your home stage (don’t pay out of state tuition), go to a public institution (don’t pay private college tuition), and if it’s AT ALL feasible, consider working full time while attending a community college for your associate’s degree and then transferring to a four-year institution.

    If you are eligible for work-study then this is a FANTASTIC opportunity I wish I’d taken advantage of – you automatically get a job, you work on campus, and they’re obligated to work around your school schedule. Plus I know lots of people who were work-study while they were in school who got offered full-time jobs with benefits in the same department they’d been working in upon graduation.

    I’d also recommend visiting your guidance office and asking about what scholarship organizations they have on file and applying for everything, but don’t stop there – get onto Google and start searching and applying for every scholarship you can find. I’m not just talking about the huge competitive ones that everyone knows about, there are TONS of little-known scholarships that are one-time and for lesser amounts of money, but every $500 scholarship you earn is $500 out of your pocket that you don’t have to spend.

    As soon as you’re in college you should also investigate whatever pre-professional organizations there are for your major/field and also start doing internships – they may not be paid at first but some are, and even an unpaid internship now usually equals lots of connections and better offers later.

    I’m sure there’s lots more, but that’s what comes to mind immediately.

  34. I would also second Anna’s observation that skilled labor is at least as good as a financial decision, and sometimes better than college. Lots of trade schools work with the industry to offer paid training and job placement upon graduation. I have only worked at 4-year universities so I’m less familiar with this option, but if I had it all to do again I’d investigate this with a lot more seriousness.

    Of course, I also recommend taking the hardest courses you can and getting the highest grades you can (though this advice you have probably already taken and if you graduate in May it comes kind of late). AP courses give credit by examination and some high schools partner with community colleges so you can earn college credits in high school. And if you can line up full-time employment for summer and winter breaks (when you’re not in school) then you can pay for a lot of expenses on your own. Or you can take coursework in winter and summer sessions and aim to graduate in 3 years instead of 4 (plus if you’re taking coursework then you can still do work-study).

    Lots of universities are offering degree programs entirely or partly online, so if you can adjust your courseload such that you are free during business hours then you can work full-time while you are taking classes (though I wouldn’t recommend this right away, since you’d want to get an idea of how much you can handle and full-time work AND school is too big of a load for lots of folks).

    There are sometimes positions open at universities that are full-time and benefits-eligible that only require a high school degree (reception, groundskeeping, maintenance/janitorial type work) and one of the benefits that universities frequently offer is tuition assistance. At the university where I work I can take up to 9 credits per semester for a flat fee of $25, for example.

    Basically, you just have to be tremendously motivated and willing to think outside the box. Which is worth it intrinsically, but also as I said, tuition prices are set to double within 4 years at the current rate of increase. You should eke out every cent you can and graduate as quickly as possible (if you can graduate in 3 years instead of 4, for example, then you avoid the tuition increase of the last year).

  35. For us, Roth is out of the question because of our combined income. We max on our 401K and I also did a Whole Life Insurance to hedge stock market disaster when we get real old. If all goes well, we won’t even need to touch it and it goes to our heirs.

    So, our approach is also to pay off our mortgage as fast as possible. We are in our mid 30′s and we have 12 years to go on our mortgage. I am carrying a baby inside and she is due in about 3 months.

    Will I do a 529 plan? Yes. but not a whole lot. Coming from an academic family (both my parents are professors in college), I know there are way too many ways to get fundings for kids’ education if you are willing to dig around and work at it. Also I think if we can send our kids to good State universities and then help them to get into top notch professional schools, it’s a much better way to save money and ensure our kids bright future.

    I went to both expensive private universities for undergrad and grad school degrees. The undergrad one didn’t really count since I have a shinning Ivy League grad school degree. So, seems like a a waste to spend that much on a private undergrad for 4 years when you can cash it all in by going to the best grad school.

  36. I agree that retirement should come before funding a child’s education, but I think that this shouldn’t be an all or nothing approach. Can’t they contribute to retirement and put a little into a 529? You’re talking about $50-$100 a month according to the article so- cut something else. They could ask relatives to give money to the 529 instead of another toy for birthdays etc.. I would also be honest with my children about finance college and about what you can fund. Since these kids won’t get financial aid and may have to take our hefty private student loans which are not low interest (mine are currently 4.5%, but were 8% when the economy was better) the parents should contribute something. In most cases you cannot pay for college while working a minimum wage job and the kids may not be eligible for need based scholarships because of their parents high income.

  37. You probably meant it in a different way that you said, but compound interest is certainly NOT the most powerful in the early years. What is powerful is the size of the underlying asset base. For example, lets say the growth rate is 6% which is realistic and let’s assume its all applied at the end of the year to make it easy. The first year we save 10000 and get 600 in interest. The next year we add another 10000 which is much higher than the 600 and we get 600 from each of the 600 and 36 in compound from the first year. This number is trivial and this is why you see early savers’ networths grow so fast. In the later years when your asset base is very large, interest (and compound interest) will be larger than contributions and this is why you see networths which are already substantially higher than the contribution being more in tune with whatever they are invested in. So what was really meant by that sentence is that TODAY a dollar saved 20 years ago is worth more than one saved 10 years ago.
    Now, it would appear that maxing out a contribution limit is a rare thing and if that is really the case, contributing early does not make a difference because the loss in compound interest can be made up later e.g. for someone who is living the middle class lifestyle with an income of 40k and a savings rate around 15%.

  38. One thing rarely discussed is Federal College loans. That’s what I used, and anyone can get them…and I mean ANYONE! They’re low interest loans, and the interest is deferred until you graduate.

    Whenever I hear someone worrying about paying for their kids’ college, I’m a little alarmed that this type of loan isn’t often mentioned. If your kid’s not smart enough to pay for their own loans by the time they’re ready for college, you have bigger problems :)

    Great article!

  39. I agree with the point of this article that your own retirement savings should take priority over paying for college.

    I agree with #6 sjw. It doesn’t sound like they plan to tap the equity of the home. Instead they are going to use their higher cash flow doe to not having a mortgage to pay college expenses. In other words, the mortgage is paid off so they don’t have to put $1000 into a mortgage payment and can instead put $12000 a year into tuition bills.

  40. I may be repeating, but this has to be said, because I think things have changed in recent years in terms of college funding (or else people who haven’t very recently been students didn’t have reason to know it). Until you are 25, or married, or legally emancipated from your parents, even once you are over 18, your parents’ financial information is REQUIRED on the federal application for student aid (FAFSA). If your parents are well-off, their “expected contribution” will be calculated high enough that you may not be eligible for need-based aid (like Stafford loans, for example). This is regardless of whether your parents plan to contribute, or can “afford” to after paying their other expenses. I know several people who could not go to college because their parents made too much money and did not contribute anything to help them, and they weren’t eligible for scholarships (merit-based). Now, can you go to community college part time, and pay for it yourself? Can you join the military? Yes, and yes – but it is a popular fallacy that anyone can borrow money from the government to attend a 4 year university. It’s simply not always true. If you are well-off, your kids may not be eligible for need based aid. Period.

  41. @Ryan,

    FWIW, I just hired an eighteen year-old young man to be a part time teller at my bank. If he enjoys is and does well, he may be able to move on to full time when an opportunity arises. If he moves to full-time, he will become eligible for tuition reimbursement. This is obviously not a good choice for everyone, but it worked for me and it is an option for him. I got hired part time at my local credit union with no experience other than waitressing. Within a year I was promoted to a supervisory position. I was already near the end of my degree program at the time, but they paid for the last few classes I needed.

    Depending on what field you want to get into, you could look into positions that offer tuition reimbursement, even if you have to pay your dues as a part timer for a few months first.

    Also, my local state college offers a payment plan. If you were willing/able to live at home, you could work a part time job and pay for college monthly. When I did this, I paid about $700 a month. Working part time as a server, I made just enough to cover all my expenses, including the college payment.

    Good luck to you!! :)

  42. @29 Laura,

    This is so true!! I was on my own at 17, and owned my place, worked full time etc at 22 but the FAFSA doesn’t care. That’s why I had to work full time throughout school. The only financial aid we qualified for was Parent Plus loans, which my parents didn’t want to do. I definitely agree with you that it is a fallacy that everyone can borrow money for college.

  43. I am a financial advisor in South Bend, IN. I completely agree with putting retirement savings ahead of college savings. This is a question I get once in a while, but if you torn between the 2, you really should put retirement savings first.

    The limits on 401(k) contributions are currently $16,500, and $21,500 if you are 50 & older. Generally you should save between 10 – 15% of your pay in a 401(k)plan or IRA. The great thing about a 401(k) is that your contributions are pre-tax dollars, so it may only cost you $75 – $80 out of your check for every $100 in contributions.

    My website http://www.helpmy401k.us also has a calculator to help you see if you are saving enough to reach your goals.

  44. Seems pretty straightforward to get legally emancipated from your parents, then – can’t you start those proceedings even if your parents object?

  45. I didn’t mention this in my first comment, but I actually want to go to college. It hasn’t been forced on me or anything. I like the “academic” environment and exploring different subject areas. I know it’s not the only option, but it seems like the right path to take.

    My main point is just that I think there’s a lot of talk about how college isn’t the only option and while that’s certainly true, people who go another route need to have a plan and an idea of what they’re going to do. Business idea, trade skill, etc.

    I think many, many people say “Oh, I’ll go to school later” or “when I can afford it” and it never happens.

    I am actually already taking classes at my community college, so hopefully that will shave a quarter or semester off of undergrad, along with AP test scores.

    Thanks for the replies by the way!

  46. @ Ryan, I’m the only person in my immediate family to go to college (so far – my sister’s going to start school finally to become a nurse – she’s in her late 20s). They think I’m kind of a weirdo, but I love everything about the university and would be miserable anyplace else, so I totally get it. Hope my suggestions are useful!

  47. “If saving for college is important to you and your family, I would probably do things in this order: retirement savings, then college savings, then mortgage.”

    I agree almost with this statement. Since the value/equity of your home is not factored into the FAFSA, I would probably rearrange the list in this order: Retirement Savings, Mortgage, College Savings. However, this being said, I find all three to be important uses of discretionary income.

  48. @Honey, Getting legal emancipation from your parents is actually a pretty complex process in most states, and requires the consent of your parents. Without parental consent, someone who essentially lives like he/she is emancipated is legally a runaway. My parents did not pay for my college education at all, but their income and assets were such that I was not eligible for any need-based aid. I looked into getting legally emancipated so that I could qualify for financial aid, but was unable to do so. For understandable emotional reasons, my parents did not support the process. My state also had very strict limits on the length of time a minor must be living with absolutely no parental support (no money provided, no staying at home, etc) in order to qualify to begin the process.

  49. Wow, I totally disagree with Honey. A person shouldn’t go overboard with crippling loans, and a person should have an idea of what the labor market is like for a graduate of a specific school in a specific chosen major… (e.g. don’t take 200K in loans to get an English PhD)

    But if you look at the difference in lifetime income among people who are college graduates and people who are not, there’s definitely room for some debt. Sure you can go to a community college or decide to get a nursing or other associate’s degree rather than a four year degree, but let that be a choice balancing all the pros and cons, not just because of an aversion to debt.

    Education loans can be a great investment, especially if you get federal subsidized loans. Yes, work part-time, but not so much that it negatively affects your learning. Take reasonable loans to invest in assets that appreciate but not those that depreciate. Your education appreciates you as an asset.

    I will say that how people view college seems to depend a lot on their family background. My family saw college as a coming of age experience, something to scrimp and save for so that we could enter the world as cultured educated adults, whether we used the degree or not. My husband’s family sees college only as the pathway to a higher paying job, only worth going to a 4 year college if doing so pays more than not. My family sees a job as a vocation, an integrated part of life. A lower salary is worth it if you get to do something you love while contributing to society. My husband’s family sees it as a way to pay the bills. It’s called work because it isn’t fun. These differences of opinion seem to drive our views on the value of a college education.

    In answer to the original poster’s question… I hope you can do all three. Retirement first, then 529s then mortgage. I had a whole lot less stuff growing up than many of my friends did, but I got to go the the college of my choice. That senior year in high school (and 4 years at a small liberal arts college) made an entire life of hot summers and hanging clothes outside and not having a Nintendo or fancy vacations (among other things) worth it. And during graduate school I knew how to be poor without suffering, which means today I can afford all the fancy appliances I want and I can stop buying things when I have enough.

  50. We are doing the pay off the mortgage early plan. We’ve maxed out retirement, have our emergency funds, and have saved smaller amounts over the last 16 years. We have 1 1/2 years of tuition from a state Tuition Trust program that we could not contribute to afte about 6 years (they stopped taking contributions), they each have savings bonds from birthdays and when some spare cash came my way, I’d purchase some I bonds, and we have cash values in insurance policies that we took out when the oldest was born. My oldest is a Sophmore in HS, and if everything works out, we’ll have the mortgage done in July of this year (YEAH!!!) That leaves 2 years of savings before she goes, plus the 4 years she’s in school. She is a hard worker too, having babysat and tutored for the past 3 years…she’s got a nice little chunk in her savings, and hopefully the jobs will continue to be there through HS, and she’ll likely find a PT job in college. She knows that she’s responsible for about 20% of her education, and we’re looking at 4 year programs in our state, probably public.
    I have heard that private institutions can offer better FA packages, so I’m going to encourage her to apply to a few of them to see what comes back.
    Also, I wanted to comment about things I’ve read about the PROFILE, the Aid form for private schools. It actually works against you to have a house paid off, and money in the bank. Crazy! We’ve found a guidebook from the Princeton Review that guides parents through the maze of college funding and vzrious ways to appear “poor” from a FA perspective (has to do with base years, starting the year your child is a Junior in HS.)We purchased this book so that we can have it as reference guide.
    One last thing. I was speaking with a friend who is a divorced mom with a Junior, looking at college. My impression was always that the father was fairly well off, and certainly would contribute to the son’s education. When I asked her if he was going to, she told me that when they were married, in lieu of saving for college, they saved all their money for retirement. He was a few years older than her. Well, he is in his early 60s and has blown through all of his retirement funds, and has nothing, apparently. So the boy knows he’s pretty much on his own, educationally speaking. I thought that was kind of sad…I imagine that’s the case for saving for everything!

  51. @Nicole #36 – since you haven’t said a single thing I don’t agree with and your advice is almost identical to my postings, I’m confused what you disagree with.

    If the options I propose are unattractive to someone’s child for whatever reason, I would totally be fine with their decision to take out loans, as long as they kept that to a minimum and felt comfortable paying it back (I got a PhD in rhetoric because I loved it, and while my student loans of $100K are a burden, they are one that I am able to shoulder without shortchanging myself in any other area – I just can’t afford to go crazy!).

    However, students should know exactly what the cutoff point of what they anticipate being able to afford is ahead of time, and have a backup plan for what they will do when that cutoff point is reached. I’m not jeopardizing my retirement to put someone else through school because that will only bite everyone in the butt later.

    However, the tuition bubble is VERY REAL, and it is going to burst, and I think that taking on significant debt for something that has a very uncertain immediate future is supremely foolish. Did you know that the Cal States have reduced their enrollments for the next year by 40,000 and are planning on tuition hikes upwards of 30% because their operating budgets have been stripped at the state level? My main point is that unless you are very, very strategic, the cost of a BA has already exceeded the amount you appreciate as a result of your education – WHETHER OR NOT you take out a loan. So why would you take out a loan?

    Deciding to go to college right now is like deciding to take out an ARM in 2006 – if you know you will be able to afford the payments no matter what and don’t mind making them even though you’re underwater on your education, that’s your business, but who can make decisions about their future income without any certainty? Yes, the average college graduate makes more money than the average high school graduate over the course of their lives, but average isn’t normal – you can’t make those statistics into some sort of guarantee that you personally (or your child) will be like that.

    If your school goes under before you graduate, then there may not be anywhere to transfer the credits to, since most universities have rules about the percentage of credit that can be transferred. Plus the market will be so glutted with people who want to go to college that admission may be impossible at any price – even if you are willing to take out ridiculous loans. And the once people start defaulting on their federal loans in droves, the taxpayers are going to have to shoulder the burden. I don’t feel like it’s ethical that people who didn’t take the risk have to suffer the consequences.

    Again, I’m not saying don’t go to college, nor am I saying don’t take out a single penny in loans. I am saying that the signs of the housing meltdown should/would have been obvious to us way in advance, had we cared to look. The tuition meltdown is coming. Look.

  52. @Sandy, When I started undergrad 7 years ago, I got the best financial aid offer from a private liberal arts school. I didn’t qualify for need-based aid, but I received a merit-based award that covered the full cost of tuition. Even with the increased living expenses associated with attending the out-of-state private school, it worked out to be cheaper than the in-state public alternative.

  53. “My main point is that unless you are very, very strategic, the cost of a BA has already exceeded the amount you appreciate as a result of your education – WHETHER OR NOT you take out a loan. So why would you take out a loan? ”

    This logic makes no sense and is also untrue on average. The average appreciation is somewhere around a million dollars (that includes opportunity costs of not working f/t during school), the cost of 4 years is only 200K full tuition at the most expensive fancy private school and much less at less fancy schools. There are assumptions you can make about rate of return on investments, but assuming credit constraints (e.g. you don’t have that 200K lump sum at age 18) and subsidized loans etc. you come out ahead on average with the college degree and a pretty large amount of loans.

    I also seriously doubt there’s a tuition bubble that is going to burst. Education costs are genuinely increasing and states are choosing to subsidize education less. It’s not like there’s rampant speculation going on. I’ll believe that health care costs will decrease before higher education costs (which is to say, not likely).

  54. It seems to me that taking out loans is the definition of speculation, and there is a HUGE loan industry out there (private loans as well as public). I would also say, if the student and/or the parents have to go into forbearance, or use the Income Contingent Repayment (ICR) plans or get to the point where your loans are discharged before they’re repaid, then that means that a) the taxpayers are the ones paying for your speculation, and b) you are never going to have a high standard of living because as soon as you get a better paying job, you’ll have to increase your payments, and you’ll only ever be making interest only payments. Earning more money over the course of your lifetime is irrelevant if you can’t afford your payments when you get out.

  55. This topic has been a sore spot for me for quite a while. I understand the need to save for retirement, but I also see the need to contribute to your childs education if you want them to be successfull. I have two daughters who attended college, one state one community. They both worked part time, were full time students, and could not get enough in grants or fiancial aid the contimue if we hadn’t chipped in. We looked on it as an investment in their future and our future. If they can’t get a job paying a living wage, we could end up “helping” them for years to come. If they have a great job, and we need a little help in our retirement, will I expect them to chip in? Absolutely! We did it for our parents, they understand that this is what families DO, they help each other as needed.

  56. There’s a lot of safety in paying off your mortgage, owning your home free and clear. We hear about all the foreclosure, no one speaks about the large percentage of Americans who own houses which are paid in full, and whose owners have been smart enough not to strip out the equity for stupid things like boats, trips, fancy cars. By prepaying your mortgage, you save a lot in pretax dollars by not having to make all those years of payments. The years of payments you don’t have to make to the mortgage company mean the money that would have gone for payments can be invested or spent. If you plan to move in less than five years you might not be so interested in this, but on the other hand, you will have more equity if you prepay. Get an amortization schedule and see how much money you can save by sendibng extra money each month to pay down principal, it’s an eye opener. It only really reaps great rewards to pay down the first half of the payments, or the first 2/3. After that, the amount of principal is enormous, the interest negligible. We are about to hit a rough patch economically as a country because the Feds and State govs are spending more than the Chinese and the rest of the world are financially able to finance. Our country is bankrupt. If you own your own home outright, YOU WILL HAVE SOMETHING OF VALUE which you can use. If America can not continue to finance its debt (think Ponzi scheme) our economy will collapse.

  57. I largely agree with Honey that the tuition increases we currently see are unsustainable and will probably lead the education bubble to burst. I went to an exclusive private university in 1995. Tuition was $17,000, which seemed overpriced and incredible to me then. They just announced that for the 2010-2011 school year it will be $39,000! Considering that wages are stagnant or in some respects decreasing, how are such increases sustainable? Already such schools like the one I attended are really just for the elite and some scholarship attendees. But even public institutions are increasing their tuition faster than the rate of inflation. And the loan burdens that current students have just boggle my mind. They will be slaves to a loan payment for years to come with no ability to pursue their dreams (unless those dreams are high-paying) or make the mistakes that young people inevitably do without going into forbearance. I just hope the bubble bursts and begins to work itself out before my young sons make it to college.

  58. @ #44 Jane – yes, tuition increased at the (public) institution that I work for by about 20% from Fall 2008 to Fall 2009, and every single salaried employee got furlough in 2009 – effectively cutting our annual pay by 10%.

    We do not expect furlough this year (thank god) but there has not been an inflation/cost of living increase for any employee in over 3 years…and we expect tuition for Fall 2010 to go up again by about 20% – and this does not count our newly instituted “economic recovery surcharge” of $36/credit hour FOR EVERY SINGLE STUDENT. They couldn’t call it tuition because then it would be covered by financial aid, you see…

  59. Institutions all over the country are also replacing retiring tenure-track faculty with adjuncts, who teach twice as much for half the pay (although most are just as credentialed as TT faculty) and offer more and more online classes, not because they are pedagogically as effective as face-to-face classes (though they are, if done right) but because you can teach more students for a fraction of the cost (no building, a/c costs). There are classes at my institutions with caps of 300-1000 for FTF instruction….

  60. I find it interesting that you note that, “I would never rely on future earnings to pay for college education,” and yet it’s OK to rely on future earnings to pay the mortgage?

  61. I am a grandparent who set up prepaid college funds for my 5 grandchildren when they were born. Now all are out of high school, two in college using the pre-paid funds, two went one year and decided they did not want college and one still has not used his fund. They have up to 20 years to use the prepaid funds and I hope they will all use them. The advantage for them is between the pre-paid funds and academic scholarships, they have not had to take out any student loans.

  62. Think of the phychological impact for both parents and children if the kids decided college isn’t for them. They may feel obligated to go to college to please the parents and will be resentful. On the other spectrum, what if the children rebel and tell the parents to take a hike? Disappointment and hurt feeling from the parents.

    By the time small children of today grow up, our government would have grown as much as Europe’s. College will likely be free. If not, let them find their own way – if they want college they can join the military or find their own scholarships or tuition assistance.

    I have a daughter that dropped out of college and has been out of work for months. My son dropped out of high school, got his GED, and is raking in $50K in this bad economy.

    All the planning in the world isn’t gonna change one thing: individuals – including your children – have free will. And they will likely use it.

    Hindsight is 20/20. I love my children but if I had to do it over again, I’d get a puppy and a cat instead of children. Animals fight less.

  63. I think our society is having a paradigm shift concerning when we should retire and what it will take to retire. With the current economic climate, and the inability for many baby boomers to retire due to lack of funds, I believe that society will move to a latter retirement age. I am in my late 20’s and I have no plans to retire until possibly 75 or latter. Personally, I want to remain a productive worker as long as possible. I also see the need that my parents and in-laws could possibly need my financial support as they get older. Since we are living longer we need to be prepared to work longer (or make a bunch of money).

    The other paradigm shift that needs to happen is concerning college education. We have a belief in our society that you can not be financially successful without obtaining a college degree. Society needs to stop thinking that every person needs to go to college, or is even capable of attending college. I understand that many people think you need to attend some sort of college program, whether technical or junior college, to prepare you for the job market, but I see that more as a failure of our public school systems. We should raise the standards of public schools and help kids identify their true strengths and weaknesses, so then they can make an educated decision regarding their future. There are many careers that have decent pay and require little if any formal training; contractor, bookkeeper, receptionist, entrepreneur, a/c repair, and many more. These careers provide the opportunity for success while the training needed does not straddle the person with loads of debt.

  64. Sandy, you’re absolutely right about the PROFILE. Many private colleges use FAFSA and the Profile to determine aid. The profile asks all those questions Fafsa doesn’t – like if you own a business, house, retirement funds, trusts, non-custodial parent assets, and more. On the flip side, it also gives you more wiggle room for possible expenses, like private school for younger siblings, large medical expenses and other reasons you might not be able to pay as much as Fafsa thinks you can.

  65. I’m with deRuiter on this.

    We are actively paying down our 15 year mortgage- we expect to be done with it at around mid year 8.

    Money that would be going to mortage can then be put into retirement AND our kids schooling.

    I am doubtful that all our 4 will be going to college. My 7 yr old is not oriented to school and seems more into the arts, shows and crafting. Obviously a lot can change in the next 10 years, but I am thinking he is more likely to be a cake chef, an acrobat in Cirque du Soliel or something arty than he is to sit thru classes at college. A 529 is not in our equation for school saving- as others have said- you can’t get at it if its not for schooling without major penalty.

  66. Our only child is graduating from college this spring. It was a pay as we went plan for us, no loans. But we realized that we would not be able to provide for more than one child based on our income so we didn’t have any more children. Personal responsibility goes a long way in limiting the financial costs. I hope that parents will rebell in mass and refuse to pay the astronomical tuition increases and the tuition bubble bursts. The student loan outfits, colleges and businesses that glom off the parents putting themselves in debt for a dubious return on investment will have to make a sea change.

  67. divajean– you can use the 529 for any post-secondary vocational training… so culinary school, trapeze academies, art school, beauty school, computer certification and so on. It is very difficult to do much when you only have a high school degree and no training after, even in vocational fields. Paying for any of those is obviously not your responsibility, but the 529 is not just limited to use at community colleges and 4 year universities.

  68. “A final note: if you haven’t saved adequately for college, you may end up being a financial burden for your children late in life.”

    I see other readers have pointed this out, but it was confusing and made me reread the paragraph and wonder if I misunderstood your philosophy. I think it’s worth fixing if that’s not actually what you meant.

  69. #13, Brent, and everyone, under NO CIRCUMSTANCES take out a loan to pay for your child’s education! Your kid might never graduate, might become ill and be unable to work, or might marry a spouse like my nephew did, and be unwilling to pay back the loan.

    My brother-in-law is now on very thin ice financially, is 57 and is some $30,000 in debt for his son’s education with no way to compel the little $#(*#@ to pay for it. The only bright side is that since it isn’t an “educational loan,” he can get out from under it with bankruptcy if necessary.

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