Naturally parents want to provide the best for their children.
For many parents, this means paying for them to earn a college degree.This is an admirable goal, and one that children will greatly appreciate when they graduate free from student loan debt.
But what does saving for the ever-rising cost of college tuition mean for their other goals?
The Gold Standard
529 plans have become the gold standard of saving for college.
This is a great choice because the plans don’t have an annual contribution limit or income threshold. They also allow tax-deferred earnings and tax-free withdrawals for qualified education expenses.
While these features are beneficial, 529 Plans also have some negative aspects.
Things to Watch in 529 Plans
The biggest drawback is savings in the plan must be used for college. Therefore if your child decides to forgo college or you have money left over, your earnings will be subject to federal and state income taxes plus a 10% penalty. So it’s a good idea to try and not over-fund 529 plans.
While the purpose of the 10% penalty is to discourage over-funding, parents should also consider how they are planning for their own future.
Too often retirement planning is put on the back burner until children are off the family payroll. However, student loan options are abundant; retirement savings loans…not so much.
In fact, parents may have enough income by the time their children go to college where they are able to pay for expenses straight from their income.
A Better Way?
For these reasons we encourage parents to consider maxing out contributions to their own retirement accounts before saving for their children.
If eligible, the Roth IRA is a tool that can work toward both goals. Roth IRAs are funded with after-tax dollars and provide tax-free withdrawals in retirement.
While this is a retirement account, a feature often overlooked allows you to withdraw your contributions from a Roth IRA tax and penalty free. So the Roth can double as a college planning tool. Just plan to max out contributions every year and withdraw those contributions for use toward college expenses if necessary.
In the event you earn enough income to where you don’t need to make any withdrawals or your child receives a scholarship, you can leave that money to grow for your own retirement.
The goals and resources of every family are unique. To develop a savings plan most appropriate for your personal situation, seek the guidance of your financial adviser.