Know the Rules of Saving for Retirement Versus College

The Squeeze

• It is possible to save for both retirement and college simultaneously, but how you allocate those funds depends on how old your kids are.
• Certain types of accounts offer enough flexibility to serve dual purposes for savings goals.
• College costs and student debt are more crippling than ever — according to the Federal Reserve, outstanding U.S. student loan debt reached $1.7 trillion at the end of 2020.

When you’re tight on cash, taking a long hard look at your financial future can bring on the stress sweats. It can be hard to imagine where the extra money you need to make either college or retirement possible will come from while juggling the myriad of daily expenses kids incur — not to mention the caregiving costs your parents may require. 

The good news is experts say whether to save for college or retirement doesn’t have to be an either/or situation. It is possible to save money for college and retirement simultaneously, but the challenge lies in adequately allocating and maximizing the funds you manage to save. 

Here’s what you need to know to figure out how much to allot to each — and the types of college and retirement plans available to meet your needs.

Start by evaluating your monthly expenses

To save money, you have to start somewhere. Firstly, review your monthly expenses to see how much money you can put away each month. When family demands and work are intense, it’s easy to let bills pile up and lose track of how much is going out versus how much is coming in. Make a spreadsheet that lists every expense you have and every cent you bring in. See where you can trim small erroneous monthly costs, like that streaming service you could watch for free on YouTube or that gym membership you haven’t been using. All those automatic withdrawals and credit card charges can quickly add up to a monthly contribution to either your retirement or college savings plan. 

Set your savings priorities

A primary benefit of many retirement and college savings plans is they offer tax breaks on the money you stash away. When deciding how much money should go to either your retirement or college plan, consider this: Worse comes to worst, your kids can figure out a way to pay for college or earn scholarships on their own, but there is no other way to fund your retirement. By the time retirement rolls around, there may be unforeseen roadblocks to consider: You may have health issues that keep you out of the workforce, have trouble finding a job, have a parent in need of extra care or support. Any money you save now could come in handy then, which is why many experts say saving for retirement should be a priority over saving for college. 

Retirement plans to consider

Traditional 401(k)

If your employer offers this option, the easiest way to save money for retirement is by making a pre-tax contribution to your company’s retirement plan. It automatically comes out of your check every month. Many companies offer to match whatever you put in, so it’s well worth putting in as much of the pre-tax pay as you can spare. Plus, you get to claim the contribution as a tax deduction for the year. 

Roth 401(k)

This newer option is ideal for those who like to get taxes out of the way as soon as possible. A Roth 401(k) only differs from a Traditional 401(k) in that it is funded with after-tax dollars up to the contribution limit. The limits are the same as with and your earnings grow tax-free. When you withdraw the funds later in life it is tax-free.  This is especially helpful if you are going to take out those funds in a lump sum, for instance, to pay off your mortgage and reduce your overall expenses. 

403(b)

If you work for a public school, religious organization, or certain tax-exempt organizations, you might be eligible to save for retirement through a 403(b) plan. Also known as a tax-sheltered annuity plan, this option allows employees to contribute some of their salary to the plan tax-free. You don’t pay taxes until you withdraw the funds. 

Traditional IRA

Saving for retirement through a traditional IRA can give you tax advantages, depending on how much you make and your filing status. Your contributions could be fully or partially tax-deductible. Plus, whatever money you save and gains you accrue aren’t taxed until you withdraw the money when you retire. 

Roth IRA

A Roth IRA allows you to save money that sits and grows with interest until you are 59 ½. It’s money you deposit after-tax, but you can withdraw the funds tax-free and without a penalty for early withdrawal. Plus, you get to claim what you contribute as a tax deduction each year. The condition with these plans is they have a tight contribution limit — only $6,000 per year if you’re under 50, $7,000 per year if you’re older. But stay tuned: this kind of account can serve the dual purpose of funding your kid’s education. 

College savings plans to consider

529 College Savings Plan

Financial institutions, states, state agencies, or educational institutions sponsor “qualified tuition plans,” which are savings plans with tax advantages used to save for education costs. Though designed specifically for college, they are sometimes also used for private elementary and secondary school costs (up to $10,000). The tax benefits offered by investing in a 529 vary, depending on the state you’re in and the plan you choose. You might be able to deduct your contributions from state income tax or receive grants. 

College 529 plans are like Roth IRAs in that you contribute after-tax dollars into a college savings investment fund comprised of bonds, mutual funds, exchange-traded funds (ETFs) or other investments, and the money grows tax-free. You can opt for a plan offered by your state or by a financial institution. It may be worth exploring programs provided by your home state first because you might be eligible for a tax deduction or tax credit for contributing. When your kids are younger, you can opt for more aggressive investments, but the older your kids get, taking a more conservative approach to investing these savings is a better idea (so you don’t lose money). 

Roth IRA

Believe it or not, IRAs are an excellent way to save for both college and retirement. You benefit from gains by investing post-tax dollars and are allowed to withdraw the funds to pay for college for you, a spouse, children, or grandchildren early without penalties. If your kid decides against college, you can keep growing the funds toward your retirement. 

Traditional savings account

A simple yet effective and flexible option is simply saving money through a traditional savings account or a certificate of deposit (CD). You might not earn as much interest or gains, but you won’t be penalized if you need to use the funds for another reason. 

Brokerage accounts

If you know your way around investments, you could always use funds in a brokerage account to pay for college. You can invest in stocks, mutual funds, bonds, currency and futures. If you know what you’re doing, you could make money, but you may be subject to brokerage, commission and account management fees.

Custodial account

The UGMA (Uniform Gift to Minors Act) and UTMA (Uniform Transfer to Minors Act) are two standard college-saving options that offer tax breaks for children under age 18. The first $1,100 is tax-free. The second $1,100 is taxed at your child’s income tax rate, and the remaining amount is taxed at your income tax rate.

Coverdell Education Savings Accounts (ESAs)

If you make under $110k ($220k for a joint account), a Coverdell Education Savings Account allows you to save up to $2,000 per year. It works like a 529 plan because it will enable you to put away money toward qualified educational expenses for a child under age 18. Though the contribution is limited, this type of account allows more flexibility in K-12 education expenses and investment choices. For instance, investors can select individual stocks.

It may not be easy; however, with so many options to choose from, it is possible to find a path that works for you.