Ask the grumpies: Retirement vs. college savings

Alice asks:

How do you decide at what income level to begin funding a 529? I know the mantra of ‘max out tax-advantaged retirement accounts first’, but that is a lot of money to put away (~30% of income) before starting any college savings…I assume we’ll be in the ‘squeezed’ middle on college, with too much income for aid but not enough to pay full freight outright. It seems that at least some dedicated college savings are worthwhile after 15-20% retirement savings, even if not optimal as far as taxes go…We’re assuming private or out-of-state public are in the cards, and want to avoid student debt. I’ve heard the ‘Roth contributions can be used’ chorus, but that won’t go far with current tuition rates.

TBH, if I had to do it all over again, I would max out retirement first instead of regularly contributing to 529s. Because of financial aid.  You can read about how our minds have changed on this topic via this cut of our archives, though I’m not sure we ever spelled out the history in one concise post.  (For an alternate cut, here’s the college tag.)

If you’d asked us this question when we started the blog, we’d have told you to make sure you were (getting any employer matches and) saving 15% of your income for retirement (more if you need catch-up savings– we’d have recommended you play with online retirement calculators to see whether or not you were on track) and then put a regular amount away for college with every paycheck.  We’d have told stories of how we knew people whose parents had spared no luxury (cds, cars, clothes, regular vacations to Hawaii, etc.) but then the kids couldn’t go to the fancy college they’d gotten into because their parents made too much money for decent financial aid and they had nothing saved.  And that’s not terrible advice– make sure you’re on track for retirement and then put money away for college to give your kids more options.  I don’t completely regret having taken it when the kids were younger.  Their college savings have grown at a nice clip, and it’s likely both will be on track to go to the private schools of their choice even without financial aid.

These days we’re much more attuned to the importance of College Financial Aid (Forbes Magazine has a great series on the topic– click here for the latest updates).  You can ignore this concern if you prefer to think of tuition as a donation to the school (which for us depends on the school… I’m always irritated at the fundraising letters we get from DH’s graduate alma mater given their endowment).  Will you be squeezed?  It turns out there are calculators for that, and those calculators depend a lot on how much money you have that can be tapped for college.  Formalized retirement savings (even the Roth savings) do not count for financial aid.  This Forbes article from 2017 is a little out of date, but should give you a good idea of how your income translates into financial aid (or not) for different types of schools.

To get an even better idea, you should pick a set of colleges that you could see your kid potentially attending, and spin through their financial aid calculators.  These individual aid calculators have become quite sophisticated and you can see how different colleges will treat your different levels of assets vs. income etc.  So you can run the counterfactuals to see that, for example, if my DH loses his job and makes no income, that won’t at all give us any more aid at Harvey Mudd (which is stingy for high-income folks and extremely expensive) or our local state school (which we could cash-flow), but would make a big difference at Harvard (which is generous up the income distribution).  (Here’s us doing those exercises and contemplating how much we would need to save for a set of private schools .  I just spun through the super simple Harvard calculator and for spendthrift high income folks with no savings, your kids can still get a scholarship at a joint parental income of 260K!  You can play with how hiding assets in retirement changes aid compared to having to report them like with a 529.  Note that Harvard is a bit of an outlier both in terms of generosity and how easy it is to use their calculator.)

Loans for college are not a terrible idea, especially if you can get subsidized loans.  You can put money away for retirement now and then take out loans for college that you can repay more quickly by contributing less to retirement later when the contributions will no longer count for college.  If you’re maxing out your retirement options today at 30%, then you can drop down to the match later when your children need the money.

Many people feel uncomfortable using money for purposes that they have not initially dedicated that money to.  For this set of people, putting money in a 529 is the only way to guarantee that a child will be able to go to something other than the cheapest college option.  If this feeling is acknowledged, however, and planned for in advance, I think it can be gotten around.  You can decide now what money you want to earmark now for college, put that in retirement funds instead, then take out loans and repay them later for the amount in question by putting less in retirement later and cash-flowing.

In terms of using a Roth to save for college– there are a couple of wrinkles to doing that.  Drawing money out while your child is still in school can decrease your financial aid eligibility because some of that hidden money turns into income.   Here’s another post with more details on the pros and cons of Roth IRAs for college savings.  Note that these cons can be gotten around by delaying when you use the Roth until the child is close to graduation, assuming that doing so will not affect a younger child’s financial aid eligibility.  (And the principal rather than the earnings can be withdrawn after college is complete for no penalty.)

College is not cheap, and it may be worth saving 30% or more of your income now knowing that some portion of that is being saved for college (in terms of needing to save less than 15% of your income later) even if you’re not earmarking it.

Now, I noted that today we regret not having put the $500/month/kid in our kids’ 529s (not to mention mortgage pre-payments) in our retirement options instead.  The reason for that is that we are now high income and we are maxing out our retirement options (DH also has much less space to save than he did when he was working for the university).  Any money we save over that amount cannot be hidden from colleges.  There are a number of pricey schools out there that we will not get financial aid at should DC1 get in and decide zie wants to attend.  (DC2 may be better off in terms of financial aid since DC1’s tuition and living expenses will do a good job of eating all of those assets.)  We’ve paid off our house, have replaced DH’s car, will replace mine sometime in the next two years (Financial aid starts counting 2 years before college starts), and are renovating our kitchen, but even after all of that we will have assets leftover that could have been hidden in retirement accounts.  We could in theory buy a bigger house or I could get something other than a sensible car, but I guess I’d rather donate tuition to a university than make those changes.  (#richpeopleproblems)  (Note that if our income goes up more, then we can ignore all of this because we won’t be eligible at any asset-level, but if DH loses his job and our income is halved, then all of this becomes extremely important.)  Here’s our most recent recommendation of what order to save for multiple big financial goals, and here’s our recommendation of what vehicles to use.  Finally, if you haven’t opened up a 529, here’s our thoughts on which one to pick.

Grumpy Nation, what are your experiences with saving for college?

 

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13 Responses to “Ask the grumpies: Retirement vs. college savings”

  1. Leah Says:

    I’m torn on this. It’s not realistic for us to max out our retirement savings. We save about 25% of our income in retirement and are not maxing out. I’ve also done calculators for retirement, and we’re on a good track. I have a spouse who doesn’t want to put any more toward retirement than we already are; he worries about over saving for retirement.

    I put a modest $100 per month each in our kids’ college accounts. I think they should get good financial aid because we don’t make tons, but I also want something in there for them, especially if they opt for trade school or community college (tho I imagine they are both college bound).

    • nicoleandmaggie Says:

      Remember that you can save less for retirement later! (But you can’t go back in time and save more for retirement in the past.)

      In the end, it’s good that you’re saving no matter where it goes, but in retrospect, I wish we’d saved more for retirement before putting any of our own money in 529s.

  2. rose Says:

    Admission to University of (State name) in my state is now so impacted it may not be possible despite classes, grades, SAT scores, sports and volunteer activites. The second tier schools State University of (State name) are simply WAAAY less powerful if you are looking for admission to any graduate program. The community college (two year program for AA) does not mean you will be admitted to the ‘University of (X) system’ and actually normally now takes 3-4 years to actually be enrolled in the required classes for admission to the renown University of X program. Which also does not graduate your child in 4 years but routinely takes 5, so any transfer in student may face 3 years for those last two years to a BS/BA. This has huge cost & planning impacts.
    While looking at costs also review admissions rates, and graduation rates+time, and admission to graduate schools IF that is part of the child’s career plans.
    Goodness I feel like a downer. So, some children get admitted, some do graduate in 4 years, some do get financial aid……. but it is a long big difference from when people in their 30’s & 40’s & early 50’s today went to college.

  3. Revanche @ A Gai Shan Life Says:

    I didn’t have the same circumstances but I sympathize with your regret. In the days when I HAD a 401K, I didn’t have enough money to contribute much but we didn’t have a kid either. By the time the kid came around, I no longer had access to a 401K either so we’ve contributed significantly to the 529 for the past few years instead. It feels sub-optimal but there’s nothing I can do with that. We max out everything we DO have access to and have some left over because we’re working hard at being frugal, specifically to save for retirement but our vehicles aren’t necessarily optimal either.

    Now I’m debating whether we keep contributing to the 529 (we don’t get any tax benefit now) or we just super focus on beefing up our retirement savings through our brokerage (no tax benefit there either). Opinions?

    • nicoleandmaggie Says:

      If you’re planning on paying for college… then yeah, the 529 makes sense (you will get a tax benefit when you sell, right?). If you move to a lower paying job that has retirement options, then you would be able to move some taxable stocks to tax-advantaged stocks at that point (by contributing via your paycheck and then selling your taxable stocks) but that’s probably not a strong possibility– you’d probably move to a job that gave you both a better salary *and* better retirement options. The 529 and the taxable stocks will be counted exactly the same in terms of financial aid (but retirement won’t count at all). The other option is to move the money you’re currently putting in the 529 into your house in order to hide it (though there are limits to how much money you can hide in your house which people in northern CA might hit even if most other people don’t). Then you might take a home equity loan out (or stop prepaying) when you hit college times.

  4. gasstationwithoutpumps Says:

    We saved 10% of my gross salary a year in a 529 plan since the day our son was born. He ended up going to UCSB (in-state), and we had enough in the 529 plan for a private school. Even with his staying for an MS we ended up with more in the 529 plan than needed—we’re hoping he has kids in the next 10–20 years, so that we can change the beneficiary on the 529 plan. I’d probably do the same, though, if we had to do it over—making sure we could afford for him to go debt-free wherever he wanted (and could get in) was more important to us than optimizing financial calculations. We can afford to send him to college, so for us to use financial aid seems to me an abuse of the system (albeit one that people much richer than us have no qualms about). We even stopped taking the token “middle-class scholarship” offered by UC after the first year.

    I also saved about 10% of gross salary each month in a 403B plan (in addition to mandatory contributions to a defined-benefit plan, which varied from 0% to 8% of gross pay).

    I’ll retire after 35 years here, getting about 85% of my pre-retirement salary from the defined pension plan, and having about 12 years gross salary in other retirement savings (403B, Roth IRA, forced deferred compensation,TIAA annuity, …).

  5. bogart Says:

    So I’ve staked a claim as a total satisficer, but contributing the maximum to your retirement options before anything else (except medical) is something I’m a pretty huge enthusiast about and practitioner of. Since the contributions are capped per year … can’t get that (right to contribute) back.

    I will say I’ll turn 59 & 1/2 while my kid’s in college (assuming typical trajectory), so — that’s easy for me to say …

    • nicoleandmaggie Says:

      That is a GREAT point! Your age matters! And for people who won’t be 59.5 until after the kid is out of college, you can use your retirement savings to pay down (low interest) loans faster when you do hit that age.

  6. Leigh Says:

    I can’t find it now, but I remember an article at TheFinanceBuff suggesting that if you could max out your 401(k) now, you could possibly replace that with cash flowing college tuition later when your kid is in college. Your state tax deduction for 529s affects this decision too.

  7. SP Says:

    I’m definitely doing this. I may open a 529, because family has expressed interest in giving money instead of gifts. My family is not wealthy and I expect these contributions to be super modest, but if it slows the onslaught of toys/clothes into our house, I’m all for it!


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