By Jennifer Nelson, Next Avenue
Mya Payton, 58, of southeastern Pennsylvania, is divorced and has 4 children, the last of whom is in school lately. “During the time my children were in school, from 2014 until today, their father agreed to pay 50% of their tuition. and some similar expenses, leaving me and Kid to fund/find the rest. “
Payton paid his percentage by liquidating the maximum of his non-retirement savings, eliminating equity in his household, and giving up all but the minimum of his self-employment pension plan (and in at least one year, without making any contributions).
To help his newest son, Payton said he plans to liquidate some of his retirement savings next year, when he turns 59 and will no longer have to pay a 10% early retirement penalty included in tax-deferred retirement savings programs. The goal, he said, is “hopefully avoiding [student] loans. “
Is this a concept or one of the worst monetary mistakes a parent can make?
Eric Nero, a qualified financial planner and president of First-Step Wealth, a comprehensive wealth-building service in Saratoga Springs, New York, says many parents withdraw or withdraw their retirement savings is a viable way to help their children pay for their education. . and no loan for graduate students.
In fact, he says, the loss of compound interest, tax breaks, time and eligibility for monetary assistance makes it one of the biggest monetary mistakes parents make.
A 2022 retirement confidence survey through the Employee Benefits Research Institute found that more than four in 10 running parents say they save for retirement because they also save for their children’s school education.
And a recent report from Morningstar, the money research firm, says parents who invest money in a school fund instead of a retirement account lose several thousand dollars in investment gains, compound asset expansion, and tax breaks that can contribute to a comfortable retirement.
That’s because contributions to pension plans like the 401(k) or classic IRA are exempt from federal and state income taxes. support.
In addition, Carey explains that a 529 plan is only pre-tax for the state source of income taxes. If a couple’s marginal federal income tax rate is 32% and they make a $20,000 contribution to a 401(k) plan’s 529 plan, they lose $6,400 in federal income tax savings.
“Not only that,” he says, “but the $6,400 lost isn’t charged over time because it’s not invested. “
Here are a few reasons why money advisors discourage parents from contributing to their children’s college budget at the expense of their own retirement:
You can’t make up for lost time or taxes. As you get older, you won’t necessarily be able to work the same high-paying job you had in your peak earning years. Therefore, you may postpone retirement savings until your children graduate hurt you financially.
Layoffs, burnout, and illness tend to hold up in the years leading up to retirement. And even adding a part-time job might not be enough to make up for lost contributions.
There are no retirement loans. While students can borrow to fund their education, parents cannot borrow to fund their retirement. Students have many years to repay their student loans. These debts can even be forgiven, depending on your child’s career. , government policy, or military programs. In August 2022, President Biden forgave borrowers $10,000 in federal student loans through an executive order.
“Even if you get a higher rate of return, your savings would only be $257,000,” says Colananni. “It’s $130,000, a big difference. Having time in your retirement account is more than less time with a higher rate of return. “
You may run out of loose money. Resolving to avoid contributing to a 401(k) plan would likely hurt more if it causes you to miss a corporate game. Many employers adjust employees’ 401(k) contributions up to a certain percentage of their salary. It is vital to take it.
“It can be an even worse resolution to withdraw cash from a 401(k) plan to pay for a student’s school expenses if the owner of the 401(k) plan is rarely 59 and still a part of it,” Carey says. you have to pay a 10% penalty for the withdrawal, as well as federal and state income taxes. Even if you’re over 59 and a part, you still have to pay taxes on the retirement and cash may not grow tax-free under the blueprint.
Beware of overloading young people. Carey thinks it’s ironic for parents to use their retirement savings to pay for their children’s school education when it makes them more likely to end up being a burden on their children by running out of cash in retirement. You can avoid this fate by contributing to your pension plan and letting the cash accumulate over time. Experts who do something different is to make their children fail. When you sacrifice your retirement savings, you force your adult children to help you for a day, anything most of us need to avoid.
You are jeopardizing monetary aid. Finally, taking cash out of your retirement savings to pay for your college degrees can make it difficult to get needs-based grants and scholarships. Colleges factor retirement savings into calculating student cash aid, but treat withdrawals from retirement savings as income.
“Speaking of a double whammy: less cash for retirement and less monetary aid, which means you’ll possibly want more cash to pay for your education,” says Taren Coleman, a qualified retirement plan advisor at College Money Smart, a service that combines college students with establishments they can afford.
The same is true if you money in equity in your home – those dollars count as a source of income in calculating need-based cash assistance.
It might seem noble to help your children pay for their education, but not at the expense of their retirement savings. Instead, look for schools that provide them with the best value for money, their trip and help them apply for all the grants, scholarships, and other grants available to them, without making a significant monetary mistake for their retirement.