Parents Raid Retirement Savings for College Expenses
/ December 9th, 2011
A recent survey from Sallie Mae and Gallup asked American families how they would cover college expenses. Twenty-four percent of parents responded they would dip into retirement savings to help with their child's tuition costs. This is an alarmingly high number and also a sign that families are keeping education a high priority. Of course, families who do this have all the best intentions in mind, however, their efforts are poorly managed. Here's why.
- In general, taking early withdrawals from retirement accounts are liable for a 10% tax penalty in addition to any normal taxes due. It is financially prudent to allow retirement savings to grow on their own and preserve their tax-deferred status. Pulling money out early does more harm than good.
- You can borrow for college but you can't borrow for retirement. When parents reach retirement age, time has run out to save more money. Once savings are used for other expenses they are gone forever and all the tax incentives for saving all these years go with it.
- How many semesters can you cover with retirement savings? Savings will run out faster than you think. If savings can only pay for a few semesters, how will the tuition get paid in the later semesters?
From a college planning perspective, parents should not rely on retirement savings to pay for tuition. The right source for college savings would be in a 529 plan, with tax incentives for saving money for college.
However, it takes several years of saving to build up any substantial 529 account. If a family has been unable to save money in a 529 plan, then they should look into student loan options to cover the rest of the bill.
One option is the Parent Plus loan offered by the Direct Loans Program. The Parent Plus loan offers a fixed rate and is a popular option with many families. The loan is only in the parent's name and begins full repayment immediately while the student is in school.
A private student loan is another alternative. Using a private loan enables the student to pay for college now and handle repayment over time. Rather than depending on the parents to use retirement money, the student takes an active role in handling his or her own tuition. Parents can co-sign with their children to help get them credit-approved while in school. Many private lenders allow for the co-signer to be released from the loan if the primary borrower makes a certain number of payments on time.
Who is paying the bills?
People take a different approach to making financial decisions based on who is actually paying the bill. When someone else pays for something on your behalf, the intrinsic value of that good or service is easily ignored. However, when you personally pay for something, you know firsthand what value is exchanged. It is no different with college students. It is wonderful when someone else can pay for tuition, but when one pays for tuition using his or her own resources, he or she tends to take that education much more seriously. Quite simply, you appreciate things/goods/services when you invest your own resources in them, and less so when someone else does the paying.
Students need to hold themselves accountable for their educational experience. Because students know firsthand what goes on at school, they can truly weigh the value of their education vs. the debt they incur. They can learn how to decide for themselves what is worthwhile. This means carefully evaluating colleges and majors, choosing what fits best. The point of going to college is to build a career and life for the future. If a student is able to do this as a result of a college education, then incurring and managing debts is a reasonable expense. It is vital that the student take ownership over his or her own education and determine what debts are appropriate and what debts are far too high to incur.
Parents should take heed. Save your retirement savings for retirement. Parents can best help their children during the college and major selection process by encouraging an objective comparison. Part of this comparison should include a calculation of debts. Then the student will know and value what opportunities they truly have for college.