Choosing where to put your savings is a question that does not have a simple answer that works for everyone. Deciding how much of your discretionary dollars to put towards retirement savings, college expenses, life insurance, an emergency fund and other buckets of money will vary depending on your unique financial situation. Here are a few arguments for prioritizing saving for retirement ahead of saving for your kids’ college expenses.
Saving as a part of your budget
The first thing that you will want to do is make sure that you’ve got a budget for your household expenses. Your budget can be simple or complex, but it’s important to have a written recording of your cash flow. Living within your means (spending less than you earn) is the number one indicator for a healthy financial situation.
Another great tip is to pay yourself first. Without a written budget, you tend to just save whatever money is leftover at the end of the month. But somehow, no matter how much money you make or how much you try to cut down on spending, there never seems to be very much left at the end of the month. If this has happened to you, transfer a set amount to a separate account right when you get paid. Many have found that when they do this, they have sufficient money to pay their expenses and are able to save more.
Saving for retirement
In addition to budgeting for your ongoing expenses, it’s a good idea to start saving for your future. Depending on where you are, you may have various medium and long-term savings goals. One common goal is saving for future retirement.
There are a variety of different vehicles for saving for retirement. With the decline in employers that offer defined-benefit pensions, a 401(k) plan is a common way to save for retirement. Many employers offer 401(k) plans, and many also offer matching funds as an incentive to contribute to them. Traditional and Roth Individual Retirement Accounts (IRAs) are another great way to save for retirement.
Saving for college
If you have children, you may also be concerned with the rising cost of higher education, and wanting to save for college. Higher education costs are currently rising higher than the rate of inflation, and more and more jobs require higher education. It’s only natural that parents want to do everything they can to help make college more manageable for their kids.
Like with retirement, there are a variety of different ways to save for college. One popular way is through what is called a 529 plan. States set these up as a way to save for college. Generally, you don’t have to be a resident of the state in question to participate in its 529 plan. Although it’s common for states to offer state tax breaks for contributing to their own 529 plan.
Another way to save for educational or other expenses is through UGMA/UTMA accounts. UGMA stands for the Uniform Gifts to Minors Act and UTMA stands for Uniform Transfers to Minors Act. The person that sets up the account (typically but not always a parent) is considered a “custodian.” They may transfer money into the account to benefit the minor, but the money is managed by the custodian.
Why you should save for your retirement first
While the exact way that you allocate your savings depends on your specific situation, here are a few suggestions for why you should save for your retirement first.
The main reason is flexibility — you can always reallocate retirement money towards higher education. If you’ve contributed to a Roth IRA, you can withdraw your contributions tax and penalty-free at any time. While many early withdrawals receive a penalty, qualified education expenses are an exception. On the contrary, you can’t easily transfer money in 529 plans to retirement savings if you end up not needing it for educational expenses.
You find another reason when considering the alternatives. If you fully save for your own retirement but don’t save much for your children’s higher education expenses, there are several different options (loans, grants, scholarships) that may be available to help pay for college. It’s also possible that federal legislation may be passed that reduces the cost for some forms of higher education.
On the other hand, if you save and pay for a significant portion of your children’s college expenses, but skimp on your own retirement savings, there will not be as many options available for you. Relying on Social Security alone is unlikely to be sufficient for many people’s retirement. Hopefully your kids got a great college education as they may be providing a good chunk of your support in your retirement!
While every situation is different, these can make for a compelling argument to focus on your own retirement saving first, and only THEN start saving for college expenses.