While parents share in the excitement and celebration of their children receiving acceptance letters from the colleges of their choice, many of them also quietly agonize over how they are going to foot the bill.
Too often, parents who have not saved enough to cover the expense end up making a last-resort choice that will impact them decades into the future — raiding their retirement savings to send their children to college.
“Parents do this because they love their children, and they see it sequentially: College now, retire later,” said Robert Fragasso, CEO of Fragasso Financial Advisors, Downtown. “It’s an emotional reaction. They don’t consider the fact that they could run out of time.
“Oftentimes those kinds of decisions are not made based on facts and projections. They are made based on emotional reactions. And that’s wrong. It’s always wrong to make financial decisions emotionally.”
At a time when many parents between ages 40 and 60 should be increasing their retirement savings, a recent report by Sallie Mae, “How America Saves for College 2014,” found just 55 percent of American families are saving regularly for college costs, and of that number, 18 percent of parents plan to use their retirement savings for college expenses.
The number increased from 17 percent in 2013.
Marie O’Malley, senior director of consumer research for the Newark, Del.-based loan provider with $7.4 billion in private educational loans, said during the Great Recession from 2008 to 2009, the number of parents saving for college who planned to take money from their retirement savings spiked to 29 percent.
“If people are using their retirement money for college, we want to get the message out that there are alternatives,” Ms. O’Malley said, referring to 529 savings plans and Education Savings Accounts, also known as Coverdell IRAs. These accounts are specifically designed for college savings and also come with certain federal and state tax advantages.
“Sallie Mae does not recommend using retirement accounts for college,” Ms. O’Malley said. “We understand why people go that route. Some people see their retirement account as a natural alternative without looking into other alternatives. It’s easy [to access the money]. But financially, it may not be the best choice for them.”
While parents may want to ease the burden of debt for their children by making painful sacrifices, financial advisers say parents must be careful about jeopardizing their financial future. Children have a better chance of fending for themselves financially because they have time on their side.
“Unless the accumulated retirement savings are clearly more than the person is ever going to need, I generally advise against using retirement savings to pay for a child’s college education,” said David Walters, a financial planner with Palisades Hudson Financial Group in Portland, Ore. “You can usually borrow to finance a college education, but no one is going to loan you money to fund your retirement.”
Parents withdrew an average of $3,256 from their nest eggs in 2013, according to a Sallie Mae and Ipsos Public Affairs survey of 802 parents of undergraduate students and 800 students. Those early distributions from 401(k) plans and IRAs can have ripple effects for years on the parent’s finances.
When parents take out loans from a company 401(k) to fund college, the loans must be repaid in five years, and if the parent leaves the job before the loan is repaid, the entire loan balance becomes due. Loans that aren’t repaid within 60 days of leaving a job are consider taxable withdrawals. The loan then is taxed as income and a 10 percent early withdrawal fee is added to Uncle Sam’s bill.
Hardship withdrawals from 401(k) plans are allowed for higher education. These withdrawals do not have to be repaid, but they permanently reduce the retirement account balance. Early IRA withdrawals also are allowed for college expenses; however, regular income tax is still due on traditional IRA withdrawals and distributions from an IRA could reduce a child’s eligibility for financial aid.
Mr. Fragasso recommends that families who are saving for college and retirement do a projection on the cost of education, and do a second projection on what money is needed for retirement security. Those numbers translate to what the family can contribute to both goals each month.
“The first thing that has to be done is projections from whatever point you are standing,” he said. “Is this freshman year in high school, where you have four years left? Is this senior year in high school and you really don’t have any years left?”
You may need third-party input to get the right projections done so you know what the right numbers are as opposed to knee-jerk emotional decisions on how much you should put away, Mr. Fragasso said. “Find out the numbers so you know that if you put 500 bucks a months into retirement, you’ll be OK.”
“And beyond that, if your debts are under control, maybe you can contribute another $200 a month for college,” he said.
“If you know what the numbers are for your retirement security and you know what the numbers are for college, then you can make discriminatory judgments as to cash flow.”
Tim Grant: firstname.lastname@example.org or 412-263-1591.