If you’re raising children, you’ve likely gone through the same internal debate that many parents go through: is it better to prioritize saving for retirement or your kids’ college?
And is there a third option that may present a better alternative?
The cost of college has risen rapidly over the past several decades, with many expenses more than doubling in the past 20 years. The annual cost of a 4-year private university has risen from $15,904 in 2000 to $45,932 in 2020 — and that figure continues to rise. These stats make it easy to worry about whether you or your child will be able to afford higher education.
But at the same time, retirement is likely the most expensive financial goal you’ll ever save for, and most people save their entire career to enjoy a comfortable retirement.
So which is more important, saving for your retirement or for your child’s college education? We’ll explore the answer to that question in this article and cover tips on how to do both at the same time.
There’s no clear answer that is right or wrong. The optimal strategy depends on your financial situation, goals, and priorities. Here’s what to keep in mind.
Retirement is vital to save for, and the earlier you start, the more time your money has to grow. Through the power of compounding interest (when your investment profits start to earn profits themselves), a saver who starts early can wind up with way more money in retirement than someone who starts just a few years later.
The typical American expects that they’ll need $1.9 million to retire comfortably. Expert opinion varies, but a good rule of thumb is to aim to save at least 10x your annual salary by the time you retire. If you earn $75,000 per year, that means you should aim to save a minimum of $750,000 before retiring.
Unfortunately, many Americans are underprepared for retirement. In 2019, the median retirement savings was just $65,000. Even when broken down by age, the median for those aged 65-74 is only $164,000.
If you have a pension at work, you may not need to save quite as much. But for most Americans, saving for retirement should be a top financial priority.
College isn’t cheap — and it presents a much more immediate expense compared to retirement. Whether you’re saving for your own college education or the education of your child, it pays to start early.
The average cost of college in the U.S. is $25,487 per year for a four-year in-state school and even higher for out-of-state or private schools. That means a four-year degree may cost well over $100,000.
Financial aid and scholarships may cover a portion of this, but most students will face significant out-of-pocket costs. Often, this leads to debt. In fact, the average student loan borrower has $36,510 in student debt.
Student debt can create a huge burden for the student and can often take years or even decades to pay off.
And yet, college is typically worthwhile — college degree holders earn significantly more throughout their lifetime than those with a high school degree.
Most people agree that attending college is worthwhile. But at the same time, it can saddle the student with significant debt. If the student (or their family) plans ahead, they can get the benefits of a college education without the burden of student loan debt.
So, which should you save for — your own retirement goals or college tuition for you or your child?
There are arguments to be made for each decision:
Reasons to save for retirement first:
Reasons to save for college first:
There’s no clear-cut right or wrong answer. However, in many cases, it may be wise to prioritize retirement savings. College can be funded with loans, scholarships, and student aid — and some students may even receive full-ride scholarships. Retirement, on the other hand, is your responsibility to save for.
Finally, remember that it doesn’t need to be all-or-nothing. Say you have $200 per month that you can set aside. That could look like:
Over a 35-year career, that $75/month could grow into over $257,000 (assuming 10% average returns). After ten years, the $125/month could grow to $15,000 if left in savings or up to $25,000+ if invested in the stock market (with 10% returns).
Figuring out how much you need to save should be a first step in drafting a savings plan.
Predicting college costs is relatively simple, as we can look up tuition costs or nationwide average costs. For retirement planning, the math is a bit more tricky. How much do you really need to retire?
According to the AARP, you should plan to spend about 80% of your pre-retirement income during retirement per year.
For example, if you earn $100,000 per year, you should assume you will spend around $80,000 per year in retirement. If you earn $60,000 per year, you should expect to spend around $48,000 per year.
Now you know how much you need to be able to spend each year, but how do you know how much you need to save?
One simple approach is to use the 4% rule. This guideline states that retirees can afford to withdraw 4% of their portfolio each year without running out of money in retirement. For example, if you have a $1,000,000 portfolio, you could withdraw up to $40,000 per year.
Using this percentage and the required amount each year, you can find your target retirement savings number. To do this, take your estimated yearly spend (80% of your pre-retirement annual income), and multiply by 25.
Simply figure out how much you expect to spend each year, then multiply by 25 to find your target savings amount. From there, you can use an investment calculator to figure out how much you need to save each month to reach your target.
Keep in mind that several factors can influence your retirement target:
When you know how much you need to save each month, you can then feel more confident setting aside additional money for other savings goals (like college).
If you do decide to set some money aside for future college expenses, there are some specific types of accounts that may make the most sense. These accounts are optimal for saving for your child’s college education — but some can also be used for your own savings.
529 plans are a college savings plan designed to help families save for their loved ones’ education. They have significant tax advantages if the funds are used for college.
Coverdell ESAs are similar to 529 plans but are a bit more restrictive in who can contribute — and how much can be contributed. They offer tax advantages if the funds are used for qualifying education expenses.
Custodial accounts are investment accounts set up by an adult (custodian) on behalf of a minor (beneficiary). The adult controls the account until the child becomes a legal adult, at which point the account transfers to the beneficiary. Custodial accounts offer the benefit of versatility — funds can be used for any purpose without any tax penalties.
So, if the child in your life goes to college, it can also help cover expenses that aren't qualified education expenses (like visiting home, buying a car to get around, etc.)
If they don’t end up wanting to go to college, they can use this money for whatever else they like — unlike a 529 or ESA.
To boost your child’s education savings, consider inviting friends and family to join in the fun. Gifting for children can be powerful, especially if those funds are invested.
The easiest way to collectively save for a child’s education is to open an EarlyBird custodial account. Funds are invested in expertly-crafted ETF-based portfolios, and any adult (grandparents, aunts, uncles, etc.) can easily contribute money to the account. Once the child becomes a legal adult, they gain full control of the account.
As a parent, it’s easy to find yourself torn between saving for your retirement and saving for your child’s education. But remember that while there are loans and other forms of aid available for college, no such financial assistance exists for retirement.
But as we mentioned, you don’t necessarily have to choose. As long as you’ve run the numbers and know you’re setting aside enough money for retirement, there’s no reason you can’t also save for your child’s education. Tools like 529 plans, Coverdell Education Savings Accounts, and custodial accounts can all help you do that.
If you’re ready to start saving for a child’s education, download the EarlyBird app today.