3 ways to balance saving for education and retirement

For many parents, especially Millennials, the memory of crippling student loan debt remains fresh or is still an issue. While the so-called student loan crisis was brewing well before Millennials were even born, their experience of graduating with excessive levels of debt, particularly during the Great Recession (December 2007 to June 2009), made this generation the poster child for what can happen when students are allowed to borrow far more than may be considered prudent, with very little guidance for parents or students to truly understand the future burden they were accepting as the loans piled up.

Not surprisingly, Millennials and other parents are keen to avoid passing along such a burden to their children and seek guidance from practitioners on the best ways to do this. With hard-won knowledge of the downsides of student debt, they are eager to take action to prevent their children from having a similar or worse experience. This can easily lead to parents prioritizing saving for their children’s education before their own retirement, which CPA financial planners know all too well is a choice the parents are likely to regret in the future.

Practitioners need to remind clients that there are no loans for retirement and then crunch the numbers to back up the advice to prioritize retirement saving over their children’s education. This may sway some parents to make the best choices for their own financial future, but as practitioners know, advising clients on the technically best way to prioritize savings doesn’t always mean that clients will follow suit. This is particularly true when the underlying emotion is guilt and there is the desire to help their children avoid the financial stress that they themselves may still be experiencing from their own student loan debt.

Beyond offering advice on maximizing education tax credits, filling out student aid applications properly, and so forth, it can be helpful to offer a few specific strategies for balancing education and retirement saving to ease clients’ concerns. That way, the message isn’t just that they should forgo helping their children pay for school in lieu of their own retirement. Instead, the aim is to find a way to harmonize these goals that may satisfy both, with a little bit of compromise. Depending on where clients are in their life and savings journey, here are three options that may help.

OPTION 1: SAVE EARLY, THEN PAUSE

The first strategy relies on the miracle of compound interest and works best for clients who have several years or perhaps decades of retirement savings built up by the time they need to pay for their children’s education. Therefore, it’s best to communicate this particular idea to clients in their earliest career years or to the young adult children of older clients.

For parents who are already in the habit of maxing out both parents’ retirement funds, one option is just to pull back on retirement savings during their children’s college years and use the freed-up cash flow to pay for education while their existing retirement savings continue to grow in the background. This strategy can run counterintuitive to the typical industry advice to always be saving, but clients often forget that the option to pay for college out of current cash flow during the actual college years exists. This is how many families paid for all of college before tuition and other costs began to soar.

With annual public four-year instate tuition averaging $11,260 for 2023–24, a family could feasibly fund up to three students per year if both parents are saving the maxi-mum allowed $23,000 into their respective 401(k) plans, allowing room for the additional costs beyond tuition. This strategy requires parents to prioritize retirement savings throughout their early career years to get to the maximum 401(k) contribution allowed, which requires foresight, while then pausing retirement savings for their children’s college years before starting it back up again once the education years have passed. It can be a simple strategy that doesn’t require parents to juggle saving for both.

An example

Katie and Tom became parents in 2022 when they were both 30 years old, with a second child born in 2024. Their firstborn, Frank, will start college when his parents are 48, with Jenny following two years later when they are 50. The parents have both been maxing out their 401(k) retirement plans at work since age 25 and plan to continue doing so until 48, when Frank enters college. At that point, they will cut back their contributions to just their employer match amounts for the six years their children are in college, before maxing out their 401(k) plans again at age 54 when Jenny is done. Based on the current 401(k) maximum contribution amount of $23,000, the parents should have approximately $3.4 million in combined retirement savings at the age of 48. If they stop contributions for six years and just let their savings grow, their accounts could still grow to an estimated $5.5 million by the time the children are done with undergraduate studies.

Note that these numbers aren’t exact, as the contribution amount would be lower than $23,000 for the first seven years of saving, but higher than that for the remaining years, so this is an estimate for illustrative sake only.

Once both of their children have finished undergraduate studies, Katie and Tom may decide to reengage in retirement savings, or they may decide that they will redirect that cash flow elsewhere to fund graduate school for one or both children, their own early retirement, or other investments. The greater point here is that creating a solid base of retirement savings early on can offer much more flexibility to trim back on savings later in the career than most clients consider.

OPTION 2: ESTABLISH LIMITS ON THE TOTAL COMMITMENT

If the retirement foundation isn’t there and parents are getting a later start on saving for any longer-term goals, a second option would be to remind them that they may choose to fund just part of their child’s college education, or they can set a limit on how much they will offer each year in support of their child. This has the benefit of teaching children how to examine value and trade-offs when selecting a school. Having a personal financial investment in their own education can promote better study habits for students who may need a boost of motivation.

Ideas for limits parents can set include:

• Funding the equivalent of in-state public tuition for four years; if a private or out-of-state school is selected, it will be the child’s responsibility to close any funding gaps.
• Offering to cover 50% of the cost, either by paying for the first two years or by chipping in half of the cost each year, while the child finds ways to pay the rest.
• Pledging a flat dollar amount each semester, allowing the child to decide whether to spend more or find ways to fit their costs into the amount offered. If scholarships are earned, the child could use that money for other costs or to save for their future.

Giving parents “permission” to save less than would be necessary to provide their child complete freedom with college education options can alleviate some of the internal conflict and feelings of guilt, as they know they are still providing some assistance to offset the potential of excessive student debt for their child. This can also help the parents to set a goal that may not seem as overwhelming as trying to fund for any possibility. Keep in mind that this option is likely to require most parents to proactively save for college in a 529 college savings plan or equivalent vehicle.

An example

Mike and Beth have one son, Nate, who is 8 years old and says he wants to be a marine biologist. While realizing that his career goal might change, Mike and Beth have already talked about being willing to pay for a four-year degree at the local University of Washington (UW), which has a reputable marine biology program. They commit to saving enough for Nate to afford this school, even if he ultimately opts to go to an out-of-state or private school.

Based on the current tuition at UW, about $13,000 per year for state residents, and assuming that the education inflation rate is 3%, Mike and Beth start saving $435 per month to a 529 college savings plan. This would allow them to save the estimated $72,000 they would need to pay for Nate’s tuition at UW as a Washington resident when he graduates from high school in 10 years.

OPTION 3: OFFER RETIREMENT SAVINGS IN LIEU

Some parents put off saving for retirement in their earlier career years to prioritize paying off their own student loans. It’s only natural that they would wish to shield their own children from having to make the same choice, but doing so doesn’t require them to continue putting off their own retirement savings to save for their children’s college education.

An alternative idea would be to encourage clients to save as much as possible for their own retirement up to and through their children’s college years. Then once their children have entered their own careers, presumably with student loan debt to contend with, the parents can contribute toward the children’s financial futures through gifts to Roth IRAs and health savings accounts (HSAs). This exploits the time value of money, by getting funds into tax-friendly retirement savings vehicles on the children’s behalf early on, while allowing the children to focus their incomes on reducing debt and saving for earlier milestones such as home purchases, weddings, travel, etc.

A fully funded Roth IRA started at age 22 could be worth about $2.15 million by age 65, requiring much lower contribution amounts than waiting until midcareer to begin saving, as many parents end up doing when they prioritize education over retirement.

CHOOSING A STRATEGY

Parents who have not saved enough to pay for their child’s college education often turn to early withdrawals from retirement funds, which not only has adverse tax consequences but may also compromise their ability to retire at all, leading to the possibility of being a future burden on the very children they’re trying to help.

With a little creativity, parents who are feeling strapped for savings during their busy child-rearing years can find some relief through these alternative college funding ideas. By helping clients to prioritize their own financial futures before funding their children’s education, you would also be helping your clients to model fiscal responsibility to their children, which can be priceless.

About the author

Kelley C. Long, CPA/PFS, CFP, is a personal financial coach and consultant in Arizona. To comment on this article or to suggest an idea for another article, contact Jeff Drew at Jeff.Drew@aicpa-cima.com.

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Article

“Help Clients Balance Retirement and Education Planning,” JofA, Feb. 1, 2018

Personal Financial Planning Section resources (section members)

The Adviser’s Guide to Education Planning, 2nd Edition

Education Planning for the Next Decade: Practical Success Strategies

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