If you start early, you’ll have more than forty years to save for retirement. In contrast, even the most diligent savers will have less than half that many years to accumulate funds for their children’s education. Does this mean that college funding should take priority once you become a parent? Absolutely not.
Don’t get me wrong. Retirement and education funding are both important household financial goals. They are competing for the same scarce after-tax dollars, so if you put more money toward one, you’ll inevitably have less for the other. But the answer is not simply to go halfsies.
In an ideal world, we would all have sufficient funds to save for a cozy retirement and also be able to send our children to an Ivy League school. But this is reality, not fantasy. Surveys show that Americans aren’t saving enough, period.
So, assuming you don’t have enough income to do everything you want to do, and maybe you’ve procrastinated a bit to make matters worse, which goal should take priority? Without a doubt, the answer is: Retirement saving should be your first priority. That’s not to say you have to ignore the other, but trust me on this-there are no student loans or financial aid for retirement.
There are three main reasons that saving for retirement should come first. First, you need to accumulate a lot more money for retirement than you do for college costs. The earlier you put money away, the more it will be able to compound over the years. If you don’t start until after your children are in college, it will be very difficult if not impossible to reach your retirement goals, particularly if you’re an older-than-average parent.
Second, retirement saving is more tax-efficient than college saving. Whether you save through a tax-deferred employer-sponsored plan or an individual retirement account, you’ll be able to put money in on a pre-tax basis and you won’t have to pay any tax on the income or growth until many years in the future when you retire. Currently available college savings vehicles require after-tax contributions and usually only exempt you from paying state income taxes.
A third reason to put retirement saving first is that it will not necessarily preclude you from being able to afford the education costs later, whereas the failure to save for retirement may mean you’ll be dependent on your children for many years in the future. Your future financial health is a gift you can begin giving them today.
One strategy that can combine both goals is to maximize your retirement savings now and then borrow the money for college when the time comes (using a student loan or home equity loan). You can even take a hiatus from paying into the retirement fund (or reduce the contribution amount) for a period of time while you repay the loan. As compared to a strategy of splitting savings between the two goals or, alternatively, saving first for college and then for retirement, this will result in the largest accumulated wealth by the time you retire. Student loans have favorable rates and, during the period of loan repayment, your previously accumulated retirement wealth is still doing the heavy lifting for you, growing in value tax-deferred.
One last bit of advice, and perhaps the most important: Whatever you choose to do, be sure that you’re contributing enough to your employer-sponsored retirement plan to get any matching dollars that are offered. For example, if your employer will contribute an extra 3% to the plan for every 3% of salary you put in, than by all means make sure you put in the 3%. Otherwise, it’s like leaving money sitting on the table. And there aren’t any matches for college saving.
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Vickie Bajtelsmit, Professor of Finance, Colorado State University College of Business, firstname.lastname@example.org