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Don't Sabotage Retirement to Pay for College

Parental loans are a last resort--and maybe not even that.

Christine Benz, 07/27/2012

Given the flagging job prospects for new college grads, as well as the soaring higher-education costs, it's only natural that families are paying attention to the payoff potential of various schools and degrees. Unless money is no object, it just doesn't add up to pay $50,000 a year for college for a child who ultimately wants to pursue a low-paying career path. That helps explain the trend of high school graduates spending two years at lower-cost community colleges before transferring to four-year colleges to earn their degrees.

That more families are conducting a cost-benefit analysis of college is long overdue, and it could help to put some downward pressure on skyrocketing tuition rates. At the same time, few can dispute the value of a college degree. The economic downturn has put downward pressure on salaries, but even recent data point to college grads earning about $600,000 more over their lifetimes than those who graduated from high school only. Given that differential, it's no wonder that sending kids to school is a key priority in so many families.

But by multitasking as so many parents do--saving for college and their own retirement at the same time--they run the risk of coming up light on the retirement front with no way to make up for the shortfall, except for working longer. The old saying about this topic is dead-on: A child can get a loan to pay for his or her college education, but no one will give the parents a loan to pay for retirement if it turns out they haven't saved enough. Given increasing rates of longevity, rising health-care costs, and what many expect will be only so-so returns from the stock and bond markets in the decades ahead, can anyone ever really be sure they'll have enough money on which to retire?

Parents can undermine their retirements in favor of college in several different ways. The most benign is to steer a disproportionate share of their savings to college that they should have earmarked for their retirement accounts instead. Pulling money from 401(k)s and IRAs is an even more direct way of giving short shrift to retirement.

Yet one method of paying for school stands out as especially unhealthy: parental loans. With college costs rising and other sources of college funding, such as investment accounts and home equity, at a low ebb, it's easy to see why the loans have jumped in popularity. Many parents probably reckon that if their kids are also taking out loans, a parental loan is a way to share the burden, or to make up the difference if student loans, scholarship, and financial aid fall short. Parent Loans for Undergraduate Students, or PLUS, have generous limits, allowing parents to borrow enough to pay for any college costs not covered by the student's financial aid package. The interest rate on Parent PLUS loans, at 7.9%, also beats the rates available on many private student loans; it's also lower than the previous rate of 8.5% that was available for parent loans under the Federal Family Education Loan program.

And at first blush, taking out a loan to pay for your child's college costs might seem less taboo than raiding your own retirement account or tapping home equity. But it's next to impossible to think of a situation when a parental loan will trump other alternatives. And if a parent loan is the only option left, it's probably wise to investigate a more affordable college plan.

Here are some of the key reasons why parents should be practically allergic to taking out loans to pay for school.

Federal Student Loans Are Cheaper
Although many parents are rightfully unhappy with the idea of hobbling their children with debt, families who can demonstrate financial need and qualify for a subsidized Stafford or Perkins loan will almost always be better off going that route than opting for a Parent PLUS loan.

Christine Benz is Morningstar's director of personal finance and author of 30-Minute Money Solutions: A Step-by-Step Guide to Managing Your Finances and the Morningstar Guide to Mutual Funds: 5-Star Strategies for Success. Follow Christine on Twitter: @christine_benz and on Facebook.

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