Save for Retirement or Save for College?

A reader writes in to ask:

“I’ve read several articles arguing that you should save for your own retirement before saving for your kids’ college. What is your opinion on this matter? Should IRA/401k contributions be a higher or lower priority than 529 contributions? And what factors play a role in the decision?”

I don’t always agree with conventional wisdom, but in this case I think it’s on-target. Retirement saving should usually be a higher priority than saving for one’s children’s college.

It’s About Flexibility

The primary reason that retirement saving should be a higher priority is that there’s a lot more flexibility when it comes to paying for college than paying for retirement. Specifically:

• You can often take out very low-cost loans to pay for college. There are no such loans available to pay for retirement.
• You get to choose when you go to college. You don’t always get to choose when you retire.
• There’s a possibility of college scholarships. There are no retirement scholarships.

In addition, IRAs offer a bit more flexibility than 529 plans in that amounts in IRAs (Roth, traditional, SEP, etc.) can be withdrawn without having to pay the 10% penalty if you use the money to pay for qualified higher education expenses. In contrast, if you were to withdraw earnings from a 529 plan in order to pay for retirement expenses, you’d (usually) have to pay a 10% penalty.

That said, if you’re already ahead of schedule with regard to retirement savings, it can be a great idea to start funding a 529–especially if your state offers tax breaks in addition to the Federal ones.

How to Know if You’re Ahead of Schedule

As we’ve discussed before, I have a strong distrust for most online retirement planning calculators. They tend to be based on such poor assumptions that the calculator’s final output ends up being meaningless.

Vanguard’s Retirement Income Calculator, however, is better than most. It can give you a rough idea of whether or not your retirement savings are on track. Still, it does make two questionable assumptions:

• It assumes a constant rate of return during the accumulation years, and
• It assumes you’ll need 85% of your pre-retirement income during retirement. (Note: If you have a better idea of how much monthly income you’ll need in retirement, you can simply adjust the “current annual income” input so that the “what you’ll need” output is more on-target.*)

Even if your retirement savings are on track though, I’d suggest erring heavily on the side of retirement savings rather than college savings. It’s easy for an investor who was on track saving for retirement to end up off track after an unexpected period of unemployment or after being forced into retirement several years earlier than expected.

*If you use the “Get your SSA.gov Social Security benefit estimate” button, having changed your income input will throw that estimate off. That said, Social Security benefits are calculated based on your 35 highest-earning years, not just your current income, so any estimate based only on your current income (even if it’s your correct current income) is unlikely to be of much value.