Many folks grapple with this situation: do I save for my own retirement or do I help my kids with college expenses?

My bottom line answer is this: your kids can get low interest loans for college — you can’t do that for retirement.

Easy to say, but there’s a lot more to it than that. Maybe you struggled with student loan debt and want a different scenario for your kids. Or the flip side, you struggled and so can they. Perhaps you had generous parents who made sure your college expenses were covered, or perhaps you worked your tail off as you went through college so as to not have any debt. No matter what past experiences you bring to the table, or which one of the savings priorities is keeping you up at night, here are some points to ponder as you contemplate retirement savings vs. college funding:

  • Employer sponsored retirement plans, such as a 401(k) or 403(b): you should be contributing at least as much as the employer is willing to match. Never pass up the free money; it is a guaranteed 100% return on your investment! (Note: your elective deferral limits for 2019 are $19,000 up to age 50 and $25,000 for age 50 and older.)
  • IRA contributions: if you don’t have an employer sponsored retirement plan, an IRA becomes even more important. Don’t forget that a non-working spouse can also contribute to a Traditional (pre-tax) or Roth (after-tax) IRA as long as the total household earned income is equal to or greater than the IRA contributions. You don’t get a “do-over” for years that you miss making contributions. It is a lost opportunity. (Note: 2019 IRA limits are $6000 up to age 50 and $7000 for age 50 and older.)
  • Income Tax Deduction: when you make contributions to your Traditional 401k or IRA, you will usually receive an income tax break on that portion of income. You will owe taxes on the income when you use it in retirement, but the tax break today may be just what you need if you are worried about cash flow. Plus, you could find yourself in a lower tax bracket in retirement making it an even better idea to defer taxes today.
  • Educational Tax Credits:  The American Opportunity Tax Credit (AOTC) and the Lifetime Learning Credit (LLC) can put up to $2,500 back in your pocket at tax time.  For the AOTC, you get a tax credit for 100% of the first $2,000 in qualified college expenses and a 25% credit for the next $2000 in expenses.  See this IRS page for more info.

Here’s an example:  parent(s) makes $16,000 in traditional contributions to a traditional 401k ($1,250 per month) with a potential savings of around $4,000 in federal and state income taxes. If you put that tax savings to work paying for $4000 of qualified college expenses for your child, you could claim educational tax credits of up to $2,500.

  • Benefit: $16,000 personal retirement savings + $480 from 3% employer match + $4000 college benefits = $20,480
  • Cost: $20,000 ($16K in retirement account + $4K to the college) – $4,000 deferred income taxes – $2,500 educational tax credit = $13,500
  • Cost/benefit ratio: $13,500/$20,480 = 66%, i.e. a 34% discount!

You just bought retirement AND college — on sale.

As always, if you need more info about this or other personal financial planning topics, you can schedule a free call or video chat with me here.

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