Many parents may have made the right personal choice by having children later in life, but they'll likely find their retirement and their kids' college years are on a financial collision course. For those parents and their planners, that could spell trouble.
"Education is so highly sought after that many parents put blinders on when it comes to costs," says David Lamp, a planner with BBJS Financial Advisors in Seattle. "It's easy to say on paper you won't need that much in retirement. This is a huge mistake, especially for older parents who have fewer years to make up for that mistake."
The issue is sure to grow because the trend of people having children later in life keeps rising. The birth rate for American women 40 to 44 years old nearly tripled from 1981 to 2009, according to the National Center for Health Statistics.
There were nearly four births for every 1,000 women in that group in 1981; in 2009, there were slightly more than 10. Almost 8,000 women older than 45 gave birth in 2009, up from about 1,200 in 1981.
PUT RETIREMENT FIRST
Most financial planners urge clients not to skimp on retirement saving to pay for college. "You can't impoverish yourself for your children," says Judy Hagar, a fee-only planner at Wolters Hagar & Pratt Financial Planning in San Diego. "The more financially sound you are, the more likely you can help kids all through their lives."
Yet Lamp has seen many clients who lived within their means for decades and then splurged on college. "One of my clients has a daughter wishing to attend the University of Denver - $52,000 a year with room and board - and he won't consider saying no," Lamp says. "But this will likely have a profound impact on his retirement."
Planners often have to remind their clients of the reasons not to withdraw money for college from a traditional IRA. "I explain that the withdrawals can throw the parents' taxable income into a higher tax bracket," Lamp says.
"It also diminishes the amount accumulated for retirement," says Susan O'Grady, a fee-only planner at Equipoise Wealth Management in Denver. She encourages clients to open and contribute to both 529 college-saving plans and Roth IRAs. She sometimes recommends that clients with a Roth withdraw from it for college costs if they're older than 59 1/2 and past the penalty phase on early withdrawals.
Some parents find that they need to stop saving when their kids enter college, diverting their usual retirement stash toward tuition and other school expenses, says Mark Cussen, a fee-only planner in Overland Park, Kan. But most clients, he says, continue contributing to their 401(k) and 403(b) plans because of the tax benefits and for any employer match they might have.
By the time children are actually in college, most of the money to pay for it should be in cash equivalents or conservative bond funds, Lamp says - separate from money in non-retirement accounts that may be invested more aggressively.
PLANNING AROUND AID
Older parents typically have more assets by the time their kids reach college age. This is one reason they might consider buying an annuity, which doesn't count in the federal financial aid methodology.
"If parents have $100,000 in taxable liquid assets, moving the money into an annuity will allow it to grow tax-deferred until retirement and improve the parents' implied financial need for the FAFSA form," Cussen says, referring to the Free Application for Federal Student Aid. "This strategy can help parents to accomplish two goals at once."
Cash-value insurance, while expensive, might also be a good choice if it leads to more aid, he says. But O'Grady disagrees, saying she didn't see the need for a "life insurance solution for retirement savings or education planning." And Lamp cautions, "The FAFSA form certainly shouldn't be the deciding factor of whether or not a client purchases an annuity product."
An option clients may not have considered is giving children assets in a brokerage account to reduce capital gains taxes. Lamp recommends that business owners consider hiring their kids. This would, in effect, shift some of the parents' income to the kids at a lower tax rate, who could then use it to cover college costs.
Many older parents expect to continue working while their children attend college. Those four extra years of income can make a big difference in their savings and Social Security payments, as well as any pension plans they might be contributing to.
"Not only do they have the money they need at that time, but they are also contributing to their retirement funds for five more years. It's a double shot in the arm," Cussen says.
However, working longer may not be in the cards for everyone, so it could be a mistake to plan on doing it it. "If you have to work longer and can do so, you will," Hagar says. "But it's inherently a faulty plan, because you may not be healthy enough, or you may get laid off and be too old to be re-employable."
One of Hagar's clients worked well into his seventies to put both of his sons through graduate school to become accountants. "I advised him to let them stand on their own two feet, but he was so proud of them," she recalls. He died a year after his second son finished graduate school.
Hagar advises her clients to make sure children contribute as much as possible toward their education. "Their kids should make some commitment - work part-time, take out student loans, get an internship their senior year. Kids whose college education is fully funded don't see the true value of it, but they do if they have to put their own money on the line," she argues.
Children also get a sense of ownership when they do their own scholarship searches. They can check FastWeb.com or Petersons.com and knock on the doors of local businesses, planners say.
FINDING THE CASH
Large retailers like Walmart often provide scholarships through neighborhood stores. For example, each Walmart awards up to two $1,000 scholarships a year; few people apply in some areas, so the money may be up for grabs.
When parents retire before their kids finish college, they often live frugally, skipping vacations or big purchases. Hagar typically conducts a cash flow analysis counting the monthly cost of college.
Monthly costs for tuition, room and board average about $1,000 at state schools, but can run as much as $5,000 for private institutions. Hagar uses software that provides updated costs for each university or college in the nation.
Older parents might also inadvertently benefit from another growing trend - college graduates moving back home and helping out with expenses until they can earn enough to live more comfortably on their own. "Kids might pay $300 to $400 in rent, which also can help parents build their retirement nest egg," Cussen says.
Katie Kuehner-Hebert is a freelancer in San Diego who's written for American Banker, U.S. Bankerand Advertising Age.