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What's the best distribution between college savings and retirement savings?

My husband and I (both in our early thirties) have two children, aged 6 and 9. We want to be saving for their colleges but don't want to neglect our retirement funds either. What's the best ratio for saving between these two funds?

Feb 14, 2012 by Mya from Allentown, PA in  |  Flag
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6 votes

529 plans, if used properly, would be my first choice, but only if you can get a state income tax deduction, and you use it in tandem with other investment vehicles such as a ROTH. There are several variables to consider, and one of the most important is the tax destructibility of your 529 contributions.

As mentioned, like a ROTH, state 529 plans allow for tax free growth of earnings, but if you get a state tax deduction you are better off using a 529 plan in most cases, at least for a portion of your college savings. For example, in Illinois the state income tax rate is 5%. State tax deductions for 529 plan contributions are allowed of up to $10,000 per person, or $20,000 per couple per year. So a couple contributing $20,000 to a 529 plan would get $1,000 back when they file their state taxes. This is a $1,000 immediate advantage over the ROTH, and this is for just a single year. Imagine the advantage over multiple years.

I encourage my clients to continue using 529 plans even when their children are in college to take advantage of the state tax deduction. It is like clipping a 5% coupon for college. This is a no-brainer. If your child is in college and you know what the costs would be, not using a 529 plan would be like leaving money on the table.

However, as mentioned above there are some risks that need to be planned for. If you do over contribute to a 529 plan you will face penalties to get the money out for non-education related expenses. You can mitigate the probability of penalties by looking at certain variables. These include how soon it will be until your children will be entering college, how many children you have, and how likely it is that your child will have all costs paid for by the college they attend.

Let’s look at each one of these. First, the closer that your child is to college, the more certain you can be as to how much they may get in scholarships and grants. Next, if you have multiple children you can be fairly certain that they all won’t all get a free ride in college (as much as we would really like this!). Money that is in a 529 plan for one child that isn’t used can be transferred to the accounts of your other children. Finally, unfortunately it is very unlikely that your child will get the majority of their college paid for, so even with large scholarships you most likely will have large out of pocket expenses. It is important to evaluate the quality of the investment options available in the 529 plan that you choose. Remember that the closer you are to the time when you will need the money, the more you should consider low risk investment choices. Also, make sure that your contributions are tax deductible in the state you live in. For example, if you live in Illinois you will get a state tax deduction if you contribute to the Illinois Bright Start program, but not if you contribute to Utah’s 529 program, even though both offer Vanguard funds. I would also suggest that you visit this website to evaluate the 529 plans of all states.


The decision to use 529 plans can be a somewhat tricky planning opportunity, but with the help of a qualified financial planner you should be able to put together a solid strategy that makes good use of the 529 plan and it’s tax advantages, while also making judicious use of other options such as a ROTH. Most people end up paying way more than we thought we could afford for our children’s college education, and the wise use of 529 plans can help reduce the burden.

1 Comment   |  Flag   |  May 13, 2012 from St Charles, IL
Craig Larsen, CFP®, ChFC

By the way, I neglected to mention in my answer above that this 529 strategy assumes that you have estimated how much you need to save for retirement, and that you have the funds available to also save for college, which was your original question! The answer to how much you need to save for retirement vs college would be best determined by building a financial plan. Until you have a chance to do that I would agree with James.

Flag |  May 13, 2012 near St Charles, IL

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5 votes

The order of contribution I generally recommend is:

(1) To the 401k first, up to any match limit; (2) ROTH IRA next, up to the maximum contribution amount. If not eligible for a ROTH, then non-deductible IRA immediately converted to ROTH. (3) 401k next up to the contribution limit (4) 529 plan, as needed ~ try to accelerate contributions insofar as possible. (5) Taxable savings.

As Robert points out, there are more ways to pay for college than to pay for retirement, and as David notes a ROTH IRA gives you the tax benefits of a 529 Plan with more flexibility. That being said, 529 plans are a great college savings vehicle if you are able to start saving when your kids are young. There are a number of excellent plans, but we favor Utah because of its low expenses and great lineup of Vanguard funds.

Comment   |  Flag   |  May 12, 2012 from San Francisco, CA

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I always recommend my clients opt for investing in a Roth IRA rather than a college plan whenever they qualify to participate in the Roth option, and here is why. First, the tax scenario is identical. You deposit after tax income into the plan, it grows free of tax, and if used appropriately, there is no tax nor penalty on the distribution. The Roth rules allow you to make distributions from the Roth IRA for your kids college expenses without taxation nor penalties, just like you could from college accounts. However, if your child does not go to college, gets scholarships for the whole thing (wouldn’t we be so lucky), or just doesn’t spend all our savings, in the college plan your only option is to transfer to another beneficiary of pay the tax and the penalty. In the Roth, anything not used for college is in our tax advantaged retirement account!

The only problem comes in if you cannot qualify for a Roth option as there are income restrictions applicable, or if you desire to save more than the allowed amount. Then either a 529 plan or Coverdall Savings plan would be a good option, you just want to make sure not to over save in those accounts either. Since college is not a certainty, you’ll want to save for both college and retirement, and I would emphasize college in the earlier years to promote tax advantaged growth, retirement later on. Hope this helps.

3 Comments   |  Flag   |  Feb 14, 2012 from East Dundee, IL
David Schlossberg, RFC, AIF

Sorry Mya, my initial sentence got chopped, and unfortunately I cannot edit it - here is the start of my reply: "I always recommend my clients opt for investing in a Roth IRA rather than a college plan whenever they..."

Flag |  Feb 14, 2012 near East Dundee, IL

Caveat - the college safe harbor for Roth distributions only applies to the early withdrawal penalty, not the tax on earnings. If owner is not 591/2, then earnings would be subject to tax. Contributions come out first, so withdrawal still might be tax and penalty free. Also, note that withrdrawal (even of contributions) can get captured on FAFSA as income and adversely impact financial aid.

Flag |  May 14, 2012 near San Luis Obispo, CA

It is important to remember that you may take a penatly free distribution from a 529 if the beneficiary receives a scholarship. Tax must still be paid on earnings but the 10% penalty is waived.

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Flag |  May 15, 2012 near Swarthmore, PA

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3 votes

Rules of thumb are tricky as one's individual circumstances always need to be taken into account but as a starting point for someone in their thirties, I would start from a baseline of 2/3 retirement, 1/3 college. While the college expense will occur much sooner, the amount needed is a fraction of what is required for a typical retirement. Furthermore, there are often additional options for financing college, including tapping home equity or low-cost student loans.

Comment   |  Flag   |  May 12, 2012 from Manhattan, NY

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3 votes


I try and make this simple when I speak to parents about college savings vs. retirement savings. Every situation is different and like others suggested retirement is absolutely the first place to maximize your savings. I find that College 529 plans work best if you must or can save for your children's college directly. The tax benefits are very powerful. A good Advisor will help you allocate your resources correctly in these cases. However, I believe that these plans better serve the generation above you....meaning grandparents. If still alive, grandparents can use these plans to great advantage from an annual tax and estate planning perspective. Gifts can be made that are tax efficient. Productive assets can be purchased without generating current income tax while the gifts grow. The assets are still owned and controlled by the grandparents, but are not included in their taxable estates should that benefit be necessary.

Another idea is to put any cash gifts your child receives from others in a 529 plan for them. This allows you to put money away for them while you concentrate on building your savings.

With this in mind, it is important to remember that you really cannot walk into a bank or lender and say I am retiring please give me a loan for my living expenses. Your child however can walk into a bank or lender and say I am going to college and would like a loan. Chances are good they will qualify for some type of loan whether government assisted or private. Hopefully they also receive scholarship and other aid as well.

Placing children second in this manner is often emotionally uncomfortable for parents. Think of it this way, we all need to make the best efforts to meet our retirement planning goals so that we do not out live our savings and potentially become forced to burden our children with taking care of us should we fall short. Often planning well will leave an inheritance that can also help our children, should they choose, with paying their loans off later in life. Hence, you helped them pay for college by providing them an asset to use later on to pay loans off.

1 Comment   |  Flag   |  Jan 30, 2015
James M. Liotta, CFP®, CPWA®, AIF®, N...

One other fact to mention with regard to 529 plans is that they are factored in when determining financial aid eligibility when owned by parents. 529 assets under a parents control are assessed at 5.64% in determining the expected family contribution (EFC) under the federal financial aid formula. Because anyone can own a 529 plan grandparents owning them and funding them not only provides estate planning benefits to the grandparent and are tax efficient as they grow, grandparents owning plans can be beneficial for financial aid purposes. 0% of grandparents assets are factored into financial aid calculations. This can be helpful with gaining access to financial aid. However when money is used to pay for college there could be a potential impact on financial aid in the subsequent year. Understanding the potential implications specific to you at that time is important to understand.

Flag |  Feb 11, 2015

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3 votes

Hi Mya,

The first step is to quantify your college and retirement goals. How much do you actually need to save for college? Is it important to you to pay 100% of your children's college education? Do you hope to send your kids to private or public university? Do some research to the costs of different alternatives.

When thinking about these questions, look at college as an investment. What will you need to invest and what will the return be? See my Brighscope.com article for details and links.


For parents of young children who are just starting their college saving, one practical way to quantify a college savings strategy is to save 1/3 of the total anticipated costs, assume another 1/3 will come from your current income while your kids are in college, with the final 1/3 paid for by your child with loans or work-study jobs.

Comment   |  Flag   |  Feb 19, 2015

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2 votes
Thomas Jensen Level 16

I absolutely agree. Make sure you are on the right track with your retirement savings first. I always tell my clients to prioritize retirement if they can' afford to save for both goals.

1 Comment   |  Flag   |  May 15, 2012 from Portland, OR
Thomas Jensen

I meant to say ... "I absolutely agree with James Dowd's comment about retirement first"

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Flag |  May 15, 2012 near Portland, OR

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Jason Hull Level 20

It's pretty noble to want to put your kids through college, but recent research shows that your nobility may be misplaced. Recent research by the University of California's Merced's Laura Hamilton shows that mean GPAs of children who come from families making more than $90k in annual income who do not give their children financial support in college is a 3.15; those who receive $16k in support dip below a 3.0; those who receive $40k in support average a 2.95.

The effect is not as great for lower income families who provide support, but it still noteworthy.

In other words, you may be better off investing in your own retirement and in teaching your children life skills like starting their own business rather than funding their college education.

Source: http://www.asanet.org/press/parents_financial_help_linked_to_lower_gpa.cfm

1 Comment   |  Flag   |  Jan 29, 2013 from Fort Worth, TX
Jason Hull

Here's an article which further examines the implications of Dr. Hamilton's research: http://cashmoneylife.com/dont-pay-for-your-kids-college/

Flag |  Feb 05, 2013 near Fort Worth, TX

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1 vote

Yes retirement first - 'your children can get student loans; it is difficult for you to get retirement loans.'

One thing to note on 529 Plans vs. Roth for taxes ... many 529 plans offer state tax deductions on contributions if use home state. Yes watch fees and investment choices, but a state tax deduction can make up for some of those sins.

Comment   |  Flag   |  Jan 18, 2013 from Western Springs, IL

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1 vote
A.J. Blackstone Level 14


In my opinion you should not separate the two. Compartmentalizing your money (Retirement, education, etc.) can have negative effects on your wealth building abilities. The 529 plan is one of the worst wealth destruction investment vehicles out there. It does not allow your money to compound over a long period of time, and the lost opportunity cost you lose in compound interest is much greater than the taxes you "save". Take a look at my article on Brightscope.com for further explanation.


Comment   |  Flag   |  Aug 16, 2013 from Tampa, FL

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