Christine Benz: Hi, I am Christine Benz for Morningstar.com.
Many people in their 30s, 40s, and 50s are balancing competing financial goals--namely, saving for college as well as funding their own retirements.
Here to discuss how to balance competing financial goals is Leisa Brown Aiken. She is a financial planner at Veo Financial here in Chicago. She's also going to be appearing at our Individual Investor Conference on January 21.
Leisa, thank you so much for being here.
Leisa Brown Aiken: Thank you, Christine, for having me here.
Benz: So, I'd like to discuss this question of how to juggle college and retirement savings, but first I'd like to ask you, is this something that you encounter a lot with your clients? Are people juggling these two competing goals?
Aiken: Almost all of my clients who are 30s, 40s, and 50s are juggling these two competing goals. All of them who have children are juggling these goals.
Benz: So, what guidelines do you give people who are attempting to navigate whether to save for which goal and how much to allocate to each?
Aiken: Well, the short answer is the conventional wisdom: Save for your retirement first. But a longer answer is, let's really think about what each of those goals means.
So, what does saving for college mean to you and what is your college savings goal? Really think about how does helping your child through college, what does that look like? How much it's going to cost and do you expect your child to contribute? Are there other sources?
So, that's the first part. Then secondly, really think about alternative ways to do it, because most people can't fully save for college and fund their retirement.
Benz: So, if it looks like someone is going to come up short for college and they are approaching college, what tools can you offer them or what advice do you share at that point?
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Aiken: So, are we talking about they are four or five years out from college maybe?
Benz: Maybe, yeah.
Aiken: So, they have a little time.
Aiken: So, some tools might be to ... start really looking at your expenses and see if you can save for college, because it's not too late to do something.
Benz: So, even if you only have a few years left, you are saying it's not too late.
Aiken: Right. Some savings will help. Savings always help. More savings are better than less.
So, it might even be that you might even increase your retirement savings thinking, well if I absolutely have to, saving early is better, and I might pull back on retirement savings when my child's in college.
If there is a stay at home, working at home parent, you might start thinking about, is there some way that that person during high school or college can generate some earnings? Or maybe my child can generate some earnings.
And then setting that target goal or budget. So what school do you want to go to? How much does it cost? Look at the sources you may have and then talk to your child. Talk to your child. Talk to your child--about the things they may need to do if they have a particular goal.
Benz: So, I know you are a big fan of including the child in the conversation even from a relatively early age.
Aiken: I am. Even from grammar school.
Benz: Okay. So, what kinds of things would you start talking about. The idea is that you're setting expectations about how you might be able to pay for college and what you might be able to pay for?
Aiken: Right. For example, when the child is in even late grammar school and ... you start to help them with their math, and you see they are learning about interest, because almost all children learn this. That's a good time to introduce that we are saving for your college; here is how much we think we might help you, and to kind of introduce to the child, here is how much it's going to cost to go to college, and here are different ways people pay for college.
And so you are setting the expectation, or you are saying, :Dad and I, or I went to X-school, and if that's what you'd like to do, here is how much it costs." So they just start to think about it and get it in their mind that there are different choices, and you don't want them anchoring on a single one, and that it cost money.
Benz: So, do you also at some point start talking about the child's goal career path? How does that figure into the mix?
Aiken: I think career paths are hard to talk about until the child is getting into middle school or high school, but yes. So, I think we've talked about, I have this English major daughter, and she's always been oriented toward writing and English. So, we started to talk about, look, you know there are trade-offs if you choose this versus an engineering or a finance career. And you will have to earn enough money to live. And if you have to borrow money for college, this is what it looks like. So, really helping them create a financial picture of what their life will look like. An engineering student can reasonably borrow more to go to college than an English major.
Benz: In terms of student loans, I know that the interest rates are pretty ugly on some of the private loans on the market. How does an analysis of borrowing costs figure into the college funding discussion?
Aiken: Here is another answer folks often don't like to hear. So, I really would prefer that parents not borrow to pay for college unless their own retirement is fully funded, because too many times people have shown up in my office who were in their 60s and they have a lot of debt or they have few retirement savings, and say, "well, we put all our kids through college," and then they are in a really tough position, and I wonder what's going to happen to them.
And with the borrowing at the student level, I would really like to see most students' target to have their total loans not be greater than their first year expected earnings, if they can, because if you think about it, that's a pretty big number, to have one year of earnings to pay back at undergraduate school.
Again, it gives an engineering student more borrowing power than a liberal arts student. And I think keeping in mind that ... the debt you can carry and repay is going to be a function of your income is pretty key.
Benz: We kind of glossed over this concept of, how much you need to retire and how to know whether you are on track for your own retirement. Do you have any guidance that you can give people, anything that you talk about with your clients in terms of factors to look at?
Aiken: I do, and I tend to think about retirement planning [being] like a very long trip to a place you've never been, and it's hard. So, ... sometimes I use ... a study in the Journal of Financial Planning in 2006 that had tables, and these are for people who haven’t even started doing detailed analysis, but it gives different ages and targets for both the level of savings at different ages and the level of debt.
So, for example, in that table, in that article, it says if you are 40 years old, a good target retirement savings is 4.1 times your income, not to have your debt above 1.25 times your income, and a savings rate, percentage of savings to income, of about 19%, which includes employer contributions. If you are around that target, maybe you want to do some more detailed analysis, but you are not in the crazy zone.
Or I might tell them, look at the studies from the Center for Retirement Research at Boston College; they just put out studies on saving rates.
Also people can use calculators, online calculators. I don’t use them, so I haven’t validated them. But what I would say is, it's the same as the calculators we use when we do these numbers for people, and one of the things to be really careful about is just that it's really tempting to back into the assumptions to make the results what you want. So, you get an answer you don’t want, so you say, "Well, I'll up the rate of return, [or] I'll lower the rate of inflation." Well, those are factors you can't control. So, if you are doing "what if" analysis, I think the saving and the spending are the things you might want to vary, and don’t assume you'll spend a lot less in retirement than you are now.
Benz: So, in your experience people have not necessarily spent less in retirement than they did before?
Aiken: In my experience they haven't, and a lot of it has to do with health care. Most of us don't see our health-care or health insurance spending, because it comes right out of our income. We are employees. So, our employer is paying a piece that’s becoming more visible, but is often invisible to us. Then when people are retired, they are going to pay Medicare Part B, their supplement, and Part D, and that's a pretty big number to be writing out of pocket, or C, taken out of your social security check.
So, often, that may offset the other things you might not be spending money on: transportation, clothes, whatever it is. Some people's spending goes up the first few years, because they have time.
Benz: They are healthy, they are traveling ...
Aiken: They are healthy, they want to play even golf, or they want to travel. So, the replacement ratio concept is really imperfect, but it's a good rule of thumb.
Benz: Lisa, thank you so much for sharing all your thoughts on these very important topics. We very much appreciate you being here.
Aiken: Thanks for having me, Christine.
Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.