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Saving for College
Dueling Goals: Saving For College and Retirement
By Dena Frenkel
Financial Advisor, Ameriprise Financial Services, Inc.
Back in the “good ole days” when people tended to have children at younger ages, they were able to take important financial goals like saving for retirement and educating their kids one at a time. Now, as the baby boomers have popularized the trend of starting families later in life, it’s not uncommon for people to face these two daunting goals simultaneously. If you are among them, here are some ways to prepare for when you’ll start tapping both nest eggs.
Start investing for both goals now
By maximizing pre-tax contributions to your employer’s 401(k) plan you get valuable benefits from tax-deferred growth. Other 401(k) advantages include:
Pre-tax contributions — Pre-tax contributions reduce your current taxable income and the amount of income taxes you owe today.
Automatic savings — By contributing with automatic payroll deductions, you don't have to worry about spending the money before it’s invested. (Such a plan does not ensure a profit or protect against a loss in declining markets.)
Matching contributions — Employer matches, when available- will usually match up to a certain level of employee contribution.
While you may be able to borrow from your 401(k) for college expenses, carefully investigate the pros and cons before doing so.
Contributing to up to $4,000 per person per year to a Roth IRA can help your retirement savings grow — even if you have a retirement plan at work. If you are over age 50, you can add another $500. And you can remove the contributions tax- and penalty-free to pay for qualified college expenses. Any remaining earnings can continue to potentially grow until you withdraw them tax-free after at least five years and when you’re over age 59 1/2. Eligibility for both the Roth IRA and the Coverdell Education Savings Account begins to phase out at adjusted gross incomes of $150,000 for joint-filing married couples and $95,000 for singles.
You may also want to consider the new Coverdell Education Savings Account (formerly called the Education IRA), which lets you make an annual $2,000 contribution to the college expenses of any child under age 18. The contributions aren’t tax-deductible but withdrawals for qualified educational expenses grow tax-free. Unused funds can be transferred to another child.
The important thing is to put time on your side by getting started with an investment plan early and staying with it. Even if you have to start small and increase your savings as you can afford it, a regular investment plan helps create discipline and over time lets you take advantage of your dollars compounding.
Decide on ownership of assets. Many experts recommend saving for college in kids’ names since it’s likely they are in lower tax brackets than you are. If that’s the case, it might make sense to establish custodial accounts if the investment income will be taxed at their rates. Keep in mind, however, that if your kids plan to seek financial aid, assets held in their names may decrease their loan eligibility.
Under the tax law, the first $700 in investment earnings are tax-free for children under age 14. The next $700 in earnings are taxed at the child’s rate. Only earnings over $1,400 per year are taxed at the parents’ rate. For kids age 14 and over, all earnings are taxed at the child’s rate.
Ownership of assets is an important aspect of college planning, so it’s important that you consult a financial advisor to weigh the pros and cons of custodial accounts on your family’s situation.
Consider your time horizon for both goals. Maybe the biggest change from the “good ole days” is the rising cost of college itself. To try to stay ahead of rising tuition costs, you may need to consider growth investments — particularly for younger children’s college accounts.
The same may be true if your retirement date is more than five years out. But, you’ll likely want to shift to a more conservative investment mix as you approach your targets dates. More aggressive investments, while they have the potential to earn higher rates of return, come with additional risk and volatility, and as with all investments it is possible to lose money.
If you are facing college and retirement at the same time, it’s important to get professional investment advice. A qualified financial advisor can help you determine how much you will need for both goals, establish a plan to get there and help you monitor your progress along the way.
This information is provided for informational purposes only. The information is intended to be generic in nature and should not be applied or relied upon in any particular situation without the advice of your tax, legal and/or your financial advisor. The views expressed may not be suitable for every situation.
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