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Do your kids a favor: Pick retirement savings over tuition

Most financial planners recommend not tapping into retirement

Most financial planners recommend not tapping into retirement savings to pay for your child's college education.  Credit: AP/Lynne Sladky

Most financial planners advise never tapping retirement savings to pay for your kid’s education. Even as college costs climb, there are still options to borrow that cash, whereas it’s often noted that you can’t borrow for retirement.

Yet about one-third of Americans with kids younger than 18 say they plan to use retirement savings or “could use if needed” to help pay for their children’s education, according to a recent survey by Sallie Mae, one of the nation’s largest student loan lenders.

The good news for retirement savings is that number is declining — in the 2016 edition of Sallie Mae’s survey, 39 percent of parents said they planned or may use retirement savings as a last resort to fund their children’s education.

More parents are now thinking twice about using retirement savings to fund college dreams, and here’s why their hesitation is warranted.

Lost retirement savings could hurt you

Paying for school from a tax-advantaged employer retirement account like a 401(k) can hurt you in several ways:

•A 10 percent tax penalty on early withdrawals below age 59½.

•A potentially bigger tax bill the year of withdrawal as the money you withdraw is counted as income.

•Loss of tax-free growth of your savings. Unlike taxable investment accounts, where you may have to pay the IRS annually for capital gains, employer-sponsored retirement accounts can grow tax-free.

•Less benefit from compounding. Early withdrawals will erode your portfolio’s growth potential.

But if you’re going to tap into your retirement savings, experts say the “least worst” option is to fund a Roth IRA. Unlike qualifying contributions to a 401(k) or traditional IRA, Roth IRA contributions aren’t tax-exempt. But as a result, there are also fewer restrictions on early withdrawals.

It could hurt your kids too

Tapping your retirement savings can boomerang to hurt your kids if they need to provide financial help for you in your later years.

“We see clients want to help their kids through college at the expense of their own retirement, and we always advise against it,” says Matt Ahrens, a financial advisor at Integrity Advisory in Overland Park, Kansas. “Parents have to understand that sacrificing to help their kids through college may only put more stress on their children when they see their parents struggling financially in retirement.”

A more immediate blow: Using your retirement funds could hurt your child’s ability to qualify for student aid. Why? The cash is considered “ordinary income” and may put your total wages for the year beyond what qualifies for assistance.

Because retirement accounts aren’t counted when considering if a family economically qualifies, “funding your 401(k) or 403(b) is an advantage for college financial aid,” says Kimberly J. Howard, a certified financial planner with KJH Financial Services in Newton, Massachusetts.

Cash them out, and that exclusion goes away.

More Americans tuck college savings into ordinary bank accounts (45 percent) than a 529 savings plan (29 percent), according to a 2018 survey by student lender Sallie Mae. But 529 plan investments have much more earning potential than ordinary savings accounts, which often grow less than 1 percent a year.

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