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Retirement vs. College Savings: Which Comes First?

Jason Stipp

Jason Stipp: I'm Jason Stipp for Morningstar. Saving for your child's education. Saving for your own retirement. Two very important financial goals that a lot of families are juggling right now. So, which one should you prioritize?

Here with me to offer some insights is Morningstar's Christine Benz, director of personal finance.

Thanks for joining me, Christine.

Christine Benz: Hi Jason, good to be here.

Stipp: So this is something that a lot of families are struggling with. They do have these two very important financial goals. If you had to pick one, if you had to prioritize one, if money is tight, which one should it be?

Benz: You want a short answer?

Stipp: Give me the short answer first, then we'll dig in.

Benz: The short answer is it has to be retirement, Jason, and the reason is that your child getting ready for college has a lot more variability. There are a lot more paths he or she could take. So they could get financial aid. They could get loans. They could attend to community college, before switching to a four-year college.

So, there are lot of different swing factors there for college kids that simply aren't there for people getting ready to retire.

Stipp: Just a lot easier for them to be more flexible in financing that particular expense at that time.

Benz: Right. No one is going to give you a loan to pay for retirement.

Stipp: That's true. So, Christine, if it looks like I do have enough money to fund both, how do I know when I put enough in that retirement part, so how do I know when I'm fully funded retirement and I can start to devote some investment dollars to college education?

Benz: Well, I would sample a range of opinions, Jason. So, if someone is working with a financial advisor, he or she should be able to provide you guidance. There are lots of great tools out there on the web as well. So T-Rowe Price's retirement and income calculator is one I really like, but bear in mind that their return expectations for asset classes are pretty lofty, so just keep that in mind as you evaluate the output.

Morningstar's Asset Allocator can also help you see whether your current nest egg is in a position to deliver you the income stream that you need during retirement.

Stipp: You also mentioned to me earlier that there are some retirement accounts that actually give you a little bit more flexibility, so as you get closer to retirement and as your children get closer to college, if you find that your situation is little brighter than you thought, there are ways that you can be flexible with those savings.

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Benz: Right. So that's one reason why I like the Roth IRA. So this vehicle is designed for retirement savings, and ideally you would save exclusively for retirement there. But it is a good multi-tasker in that you can withdraw your contributions at any time for any reason without paying a penalty or any sort of taxes. And then you can also withdraw the investment earnings component, provided you use it to payer higher education expenses for yourself or your child, and you can do so free of penalty, but you will owe ordinary income tax on that money if you withdraw prior to age 59 1/2.

Stipp: But certainly something that allows you to go ahead and save for retirement right now and then you could use some of those dollars for college later if it looks like you have the ability to do that.

So, as I'm setting goals and I'm thinking about how much I might be able to afford, how can I start to get my hands around, how much I might be able to contribute for college education and when do we bite off too much to chew for college expenses.

Benz: Well, it's never too early to start that process, so there is a nice tool online called FAFSA4caster. It will help you see how much financial aid that your family will qualify for. That's a good starting point, and once you start to get your head around some of those numbers, start having that discussion with your child.

So I think the last think you'd want to happen would be for your child to apply to the school of his or her dreams, get in and then later find out that it was simply out of your family's financial reach. They should still apply, but you still want to have the fact that you may not be able to afford it in the mix, discussion-wise.

Stipp: Another thing, I think that sometimes families will overlook is the fact that they might have several children that might overlap a little bit in their college expenses and that can really create a pinch.

Benz: Right. So a lot of families focus so much on that first child: How we are going to pay for the best school that he or she can get into? But think about all of them and think about the fact that you may have some of that uncomfortable overlap. A lot of families I've known have fallen into this, and it's created a terrible financial pinch, although, you also may be able to qualify for some additional financial aid in those very hard years, too.

Stipp: So, Christine, you invest for college, but college is also seen as an investment in an individual. There's a lot of decisions that go into the choice of a college, a lot of intangible decisions, but you also do want to make sure that you're getting a good value for the money that you are spending for that tuition. On the financial side of that equation, how can I know that I'm going to get a good return with my college choice?

Benz: Well, it's a tough question, Jason, and there are so many intangibles, but I do think that getting your child thinking about career pathing, as much as a 17- or 18-year-old could started thinking about careers. Talk about whether that very expensive school is must if he or she is going to strive for a certain career path. There may be cheaper ways to get your child to that ultimate career goal.

Also, there have been some interesting studies about return on investments for various college trajectories, so in this study that came out within the past year or two, it looked at in-state students at public universities actually had the highest return on investment versus some other college students. What they also found, though, was that the big-name Ivy League schools still delivered a very high ROI for their children as well.

So take a look at some of those ROIs, although understand that they don't factor in some of those very important intangibles.

Stipp: Certainly, Christine. Thanks so much for you insights and tips today.

Benz: Thanks, Jason.

Jason Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.