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Should You Save for the Kids’ College-Or Retirement?

A large financial burden is put on parents these days. In addition to making enough to live comfortably, you’re expected to save hundreds of thousands of dollars for retirement—through careful investing throughout your adult life. In addition, you’re supposed to pay for college—and the cost for that can be in the tens of thousands per year.

For some lucky families, saving for both college and retirement isn’t a problem. But for many, it can be difficult to decide which to give priority to—and it’s not easy to afford both. In addition, saving for college beforehand can actually hurt you when it comes to financial aid. Here’s an overview of the things you should keep in mind when deciding how to allocate your extra funds.

Money saved in retirement accounts isn’t counted as available for college

When assessing how much parents have in financial resources to contribute to college, the school and the federal government take a lot of things into account—including home value, salaries, and investments. But they don’t count retirement assets saved in 401(k)’s, IRA’s, and other accounts. If you put your extra money into savings, colleges will know it’s there—and raise the amount of your expected contribution accordingly, while lowering the amount of need-based aid you’re entitled to. If you save it in a retirement account, they won’t.

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Everyone’s situation is different—and a financial advisor may be able to help you make the decision that’s right for your family.

Colleges don’t make allowances for your need to save for retirement

When colleges calculate your ability to make out-of-pocket contributions to your child’s tuition, they don’t take into account that you have to save for retirement—even if your employer doesn’t offer a pension and you have no retirement account.

And if you contribute to a 401(k) while your child is in college—in order to make up for all that time you spent scrimping for your child’s education rather than your own retirement—it could decrease the amount of federal income tax you pay. Which, twisted as it sounds, could decrease the amount of aid you get—as colleges look at it as additional income.

You can’t borrow for retirement. Another factor is availability of loans. While you can’t borrow to finance your own retirement, you can borrow to finance a child’s education—if you have to.

Withdrawals from retirement accounts are counted as income

If you have to withdraw from your retirement fund to pay for college, it could come back to bite you. Any withdrawals you make to pay for college out of a retirement account are counted as income to you—even if the money went straight to the school. And that income can be taxed, subject to early-withdrawal penalties in some cases, and used to reduce your eligibility for aid the next year. Most financial advisors will tell you that if you need to use retirement funds to pay for college, wait until the last year—so it can’t damage aid eligibility the year after.

That doesn’t mean you shouldn’t save—if you can

Especially if you have the extra funds and know you won’t be eligible for much need-based aid anyway, it might be smart to invest in a 529 plan. 529 plans work much like a Roth IRA for retirement—the money you put in is taxed as income, but it’s not taxed when you withdraw. And in 34 states, you can get a state income tax break for at least some of your 529 contributions.

Be careful when choosing a 529

All plans are different, and fees can vary widely—even though they’re state plans, they’re administered by private financial firms. Also, bear in mind that most states that provide tax breaks for contributions to 529 plans, those tax breaks are only available to contributions made to the state-affiliated plan. Your state plan may or may not be the best investment choice—so do your research.

Overall, many parents are counseled to prioritize retirement savings before their children reach college age, reduce retirement savings while they’re in college to pay for tuition and other expenses, and then start focusing on retirement again once the kids have graduated. But everyone’s situation is different—and a financial advisor may be able to help you make the decision that’s right for your family.