Paying for your children's college educations should actually be placed quite low on the totem pole of financial priorities. Why? There are several reasons for this, such as the availability of tools to pay for college, such as financial aid in the forms of student loans, grants and other programs where loans are forgiven in exchange for public service in low-income communities. But ultimately, it's also because focusing too much on college savings can jeopardize a family's overall financial planning strategy.
First Things First
Some family financial needs may be a good thing, like college for other children, or they can be tragic, like long-term care costs for the parents themselves or medical expenses for grandparents. Devoting too many resources to college savings can cut into preparing for inevitabilities such as retirement which - unlike financing college - can't be funded by loans.
Since college costs these days are skyrocketing, how should parents prioritize their saving and investing plans? Consider adhering to the following priorities, in this order:
- Establish an emergency fund. It's critical to establish an emergency fund with at least six months worth of living expenses. This is a key building block for meeting a family's basic financial needs. After all, what if you have a job change or you get laid off? If you don't have six months worth of expenses to fall back on, you can't go into that 529 account and take money out without a penalty and taxes.
- Fully fund employer-sponsored retirement plans. A major mistake many people make is reducing contributions to their employer-sponsored retirement plan in favor of investments toward a child's education. Instead, the priority should be in making as large a contribution as possible into a 401(k) or 403(b) plan. Doing so not only enables you to take advantage of any employer match available, it also provides potentially significant tax advantages.
- Take care of insurance needs. Too many parents make the mistake of ratcheting back on life or disability income insurance in order to save for a child's education. But if something bad should happen, both college and a family's most pressing needs may be in jeopardy. If the primary breadwinner isn't working and doesn't have income coming in for a long period of time, then college is, in many cases, out of the question. Parents should save for college while simultaneously retaining insurance coverage.
- Don't forget IRAs. It's crucial to continue funding both your Traditional and Roth IRAs as much as possible. Roth IRAs are particularly good in case parents want to use some portion of those assets for college, because in some circumstances, after five years the contributions into a Roth IRA can be withdrawn income tax and penalty-free. Roth IRA earnings taken prior to age 59½, may be subject to a 10% federal tax penalty and possibly state income taxes.
While financing all or part of your child's college education is a worthy goal, it's critical to keep your family's overall financial picture in mind when making financial planning decisions.