September is “National College Savings Month”, a campaign ostensibly designed to send worried parents scurrying off to set aside some money for their children. But before you moms and dads divert your dollars towards this specific purpose, there are a few financial goals that should be given priority.
Save for retirement
You and your kids can borrow money to pay for higher education expenses, but you can’t borrow money to retire. Therefore, selfish as it might seem, you need to put your retirement needs ahead of your child’s college costs.
It’s not just urgency that makes “saving for retirement”, it also makes good financial sense. First, every dollar saved to an at-work 401k ,403b, or your own IRA reduces your next income tax bill by 10 to 40 cents.
That money saved in retirement plans will also not be counted in the “expected family contribution” that determines how much need-based financial aid your family may receive.
But if you need to continue saving money for retirement while your kid is in college, the contributions you make during that time will reduce the amount of need-based financial aid you receive.
Use a Roth IRA
A Roth IRA can help you simultaneously save for retirement and higher education expenses. If you qualify, you can contribute the lesser of your earnings, or $5,500 ($6,500 if you’re over 50).
You can also make a spousal contribution for a stay-at-home husband or wife up to the aforementioned amounts.
As you get closer to your planned retirement age, you may find that you need the funds in the Roth IRA to support yourself. If so, you generally can withdraw the money from the account tax-free, as long as you’re over 59 ½.
But if you can afford to spend the money on your child’s college costs (or any other expenditure), you can pull the contribution portion of the Roth IRA out at any time for any reason with no taxes or penalties whatsoever.
For example, let’s say your child is eight years old, and you decide to start saving $5,000 per year into your Roth IRA. Over the next ten years, your annual deposits and the (hopefully) positive investment performance bring the total to $70,000.
You can then pull up to $50,000 (ten annual contributions of $5,000) from the Roth IRA to pay for college expenses (or anything else), with no taxes or penalties.
Once your contributions are withdrawn, if you pull out the remaining amount and you’re under 59 ½, you could be hit with income taxes and a 10% penalty.
Pay off the right debt
It’s tempting (and sometimes wise) to try to save money by paying off your debt as soon as possible, even if it means sacrificing retirement and college savings for the time being.
But until those other goals are met, the only loans you should pay down prematurely are high-interest consumer loans and credit cards (generally, those charging more than 10% annual interest).
Any extra funds should go towards saving for retirement and paying for college, and you should make only the minimum monthly payments required on vehicle loans, mortgages, and even student loans.
In fact, if you think you may not have enough money to pay for looming higher education expenses, you should not only make the minimum payment on your mortgage, but consider refinancing to a new, 30-year, fixed-rate mortgage for as much as the lender will allow.
The low, potentially tax-deductible interest rate and long repayment period will help your family survive paying for out-of-pocket higher education expenses, and/or any other financial emergency that comes along.
Once you’re certain that college costs won’t be an issue, you can use any savings in reserve or unneeded income to pay the mortgage off sooner than the 30 year schedule.
But our guess is that over the next three decades, something will come up that makes you glad you have the money from the mortgage, and the lower monthly payment that refinancing could provide. .