Here’s the biggest difference between retirement savings and college expenses: you can get a loan for college. No financial institution will give you a loan for retirement. Therefore, when it comes to finding money for college, financial planners and estate planning attorneys agree, as does this article from the Star Tribune: “Do your kids a favor: Pick retirement savings over tuition.”
The number of people who are making that decision are on the decline. The 2016 edition of that survey is down from 39%. It’s good that more parents are thinking twice about making this financial mistake.
Paying for college expenses from a tax-advantaged employer retirement account, like a 401(k), can become very costly. Here’s why:
- How does a 10% tax penalty on early withdrawals, if you’re under 59½ sound? Not good.
- The money you withdraw is taxed as income.
- You’re losing the tax-free growth of your savings. Remember, these retirement accounts grow tax-free.
- You lose the benefit of compounding, so your growth potential is losing ground.
The “least worst” option, say experts, is to fund a Roth IRA. Unlike qualifying contributions to a 401(k) or traditional IRA, the Roth IRA contributions are not tax-exempt. As a result, there are fewer restrictions on early withdrawals.
However, you’re still losing out in many ways. This includes when you get further along into your retirement years and you don’t have enough money to support yourself. Take a very long-term perspective on what will happen in the future.
Parents must understand that while it’s nice that they want to sacrifice to help their children through college, they may actually be generating far more stress for their children when the kids have to help Mom and Dad later in life. That’s likely when their kids are having children of their own, paying a mortgage and saving for their own children’s college expenses.
One last, major consideration is: college aid. Your withdrawals from retirement funds will be counted by financial aid offices as ordinary income. If it pushes your total wages up too high, your college-bound student may not qualify for assistance.
Retirement accounts are not counted, when considered if your student qualifies for financial aid. Therefore, your best bet is to continue funding retirement accounts. If you start cashing them out to pay for college expenses, everyone loses in the long run.