Don’t Raid Your Retirement Savings to Spare Your Children Student Loans

Over half of the parents who participated in a recent T. Rowe Price survey indicated they would rather withdraw money from their retirement account, delay retirement for a few years, or work an additional job than have their children take out student loans to pay for college. If you are in that group, please reconsider because sacrificing retirement savings to spare your children student loans is a big mistake. Here’s why:

  • You cannot fund your retirement with borrowed money.  While your children have the option to borrow money to finance a college education, you don’t have that luxury when it comes to financing your retirement; you will need savings.  The vast majority of Americans have not saved enough for retirement.  You cannot afford to tap your retirement savings to pay for your children’s college education.
  • Your children will have forty years to pay back student loans and save for their retirement.  Your children have their entire lifetime to build their fortunes; you have less than twenty years to secure your retirement.
  • There are other ways to pay for college in addition to student loans and your retirement savings.  Funding the costs of a college education is not an either/or proposition:  student loans or your retirement savings.  Your children can pay for part or all of their own college education with scholarship money, wages from part-time employment during the school year and full-time employment during the summer,  by taking evening classes while working full-time,  by delaying college to work full time and save for college expenses, and so on.  See my post How to Graduate from College with Less Student Loan Debt for more ideas.
  • Delaying retirement may not be an option.  Recent surveys confirm that a significant percentage of American workers retire sooner than they had planned, usually due to health reasons or a layoff.  You may not be able to work longer to compensate for the retirement savings you spend on your children’s education.
  • Working a second job is easier said than done.  The rewards of working a second job will be far less than you imagine them to be; see my post The Hazards of Chasing Additional Income.  If you are a professional, moonlighting will probably detract from your performance at your  primary job.  Do you really want to put your full-time job in jeopardy to earn a few extra bucks so your children can graduate from college free of student loan debt?

Your children will be the beneficiaries of their college degrees by way of increased earnings over their lifetime.  Let them invest in themselves by financing their college education with scholarship money, their own earnings, and if necessary, student loans.  You can help them avoid unreasonable student loan debt by encouraging them to make financially prudent decisions with regard to the cost of their higher education.  I know from experience that if a child has a financial stake in her higher education, she will get more out of the college learning experience, because she will be motivated to put more into it.  It’s her money on the line.

Plan ahead and save for your children’s college education

If you feel you must pay for part or all of your children’s college education, then make a plan to save for it along with your retirement.  Start early and save aggressively.  To successfully finance all or part of your children’s education as well as your own retirement, you will need to keep a lid on your standard of living so you have the money available to adequately fund college and retirement savings simultaneously.  Use a 529 plan to accumulate college savings tax free.

Financing college with student loans is a good investment

Whatever course you take, don’t try to make up for lost time by raiding your retirement savings to avoid student loan debt for your children.  You cannot afford it.  Besides, repayment of student loans should not be viewed as a hardship.  When done prudently, financing a college education with debt is a good investment.  It is well worth the interest paid on a student loan to obtain a marketable college degree that will pay for itself many times over though an increase in earning capacity.

Average student loan debt for those graduating in 2014 was $ 28,400 about the price of a new, mid-sized automobile, less than the average cost of a wedding ($29, 858), and a whole lot more valuable.  Your children can handle student loan debt and prosper with a little guidance from you.

K. C. Knouse is the author of True Prosperity: Your Guide to a Cash-Based LifestyleDouble-Dome Publications, 224 pages

Use of Income Tax Refund Is Indicator of Financial Condition

How you  use your income tax withholding refund often indicates the condition of your personal finances at the time.  Consider the following examples:

  • Obtain an income tax refund advance loan to finance a trip to Disneyland:  You are willing to pay interest and/or fees for money you would receive anyway.  This indicates that you have little or no savings, lots of debt, and a compulsion to spend.  You could have saved the interest and/or fees on the refund advance loan by simply waiting a few weeks to take your vacation.  Financial Condition:  Out of control.
  • Use income tax withholding refund for down payment on a new car: You use your income tax withholding refund to get deeper in debt.  This indicates that you have little or no savings and a lot of debt.   Financial Condition:  Serious.
  • Use income tax withholding refund to catch up on payments and bills:  This indicates that you have no savings and a lot of debt.  You not only spend more than you earn, you cannot even make the payments on your debt.  Financial Condition: Critical.
  • Use income tax withholding refund to pay cash for a new leather sofa:  You prefer to spend money rather than use it to improve you personal finances.  This indicates that you probably have some savings and debt, but no financial goals.  Financial Condition:  No improvement.
  • Use entire income tax withholding refund to pay down or pay off debt:  You are concerned about debt and take advantage of an opportunity to pay it down or off.  This indicates that you probably have an emergency fund, some debt, a budget, and a plan to pay down or pay off your debt.  Financial Condition:  Improving.
  • Use income tax withholding refund to add to savings and to pay off or pay down some debt:  You use your entire income tax refund to improve your finances in a balanced way.  This indicates that you probably  have an emergency fund, some debt, a budget, and a plan to pay down or pay off your debt.  Financial Condition:  Fair.
  • Use entire income tax withholding refund to add to savings:  Accumulating savings is a high priority for you.  This indicates that you probably have little or no debt, an emergency fund, a budget, financial goals, and a plan to attain your goals.  Financial Condition:  Good.
  • Use 25% of your income tax withholding refund to purchase a new television and the rest to add to savings:  You balance the use of your income tax refund between spending and saving.  This indicates that you probably have no debt, an emergency fund plus other savings, a budget, financial goals, and a plan to attain your goals.  Financial Condition:  Excellent.

Of course, the examples above are based on broad assumptions and generalizations, but that doesn’t mean they don’t contain a nugget of truth.  An income tax withholding refund offers an opportunity to improve your finances, even if that means just getting caught up with your bills and payments.  Take advantage of the opportunity and build on it in the year to come by creating a budget and a plan to save regularly while paying down your debt.

K. C. Knouse is the author of True Prosperity: Your Guide to a Cash-Based LifestyleDouble-Dome Publications, 224 pages

Target Retirement Income to Determine Your Retirement Savings Number

When determining how much money you need to accumulate to enjoy your idea of a comfortable retirement, you can use several methods.  The easiest is to go with a number that financial planners think will be needed for a secure retirement, say $ 1.3 million dollars.  The next easiest is to use a formula.  One popular formula is based on a multiplier of your current wage.  That multiplier ranges from 15 times your current annual wage to 22 times your current annual wage, depending on the source.  A third way is to target the amount of income your retirement assets will need to produce.  In other words, in addition to a company pension, if any, and Social Security, how much additional income will you need to maintain the standard of living you want in retirement.  Once you have estimated that amount, you then calculate how many dollars of retirement assets it will take to produce that income given what you consider to be a reasonable return on those assets.  The result is your retirement savings number.

Targeting retirement income keeps it real

I prefer targeting retirement income because it keeps you in reality.  After all, retirement income is the whole point of saving for retirement; it is not how much you have accumulated, but how much income it can produce that counts.  This is an important distinction, because it is easy to get distracted by large amounts of money as your retirement assets grow.  People most often talk of the amount of money they have in retirement savings when they talk to me about retirement security.  They think two or three hundred thousand dollars in retirement savings is a lot of money.  When I point out that two or three hundred thousand dollars in retirement savings will only produce $8,000 to $12,000 in annual retirement income, they are often shocked and surprised.  Suddenly, what seemed like a large sum of money isn’t so large anymore.  Don’t get me wrong, two or three hundred thousand dollars is a large sum of money, but not when someone needs $20,000 or $30,000 a year to supplement pension and Social Security income.  In reality, it is a good start.  Unfortunately, these people are often in their late fifties or early sixties with limited time to add to their retirement savings.

The truth is most people save all of their lives for retirement but don’t really know what they are saving for.  They assume that because they have accumulated hundreds of thousands of dollars it will be enough money to secure their retirements.  Not until they are at the threshold of retirement do they consider just how much income they will need in addition to pensions and Social Security to maintain their standard of living.  Often they come up short.  True they have accumulated a large nest egg, but it isn’t nearly large enough.

Targeting retirement income accounts for change

Another reason to target retirement income is change.  The amount of money you will need in retirement is likely to change many times as you progress through life.  Your standard of living, your values, and your income will probably change over your working life.  Living standards and income may go up or down or up and down.  Rosa and I certainly experienced those types of changes.  What you value may change, as well.  You may become more materialistic or less.  You may decide to settle for a more modest standard of living and retire early, or work additional years beyond traditional retirement to enjoy a more lavish lifestyle when you retire.  Don’t forget external changes such as the rate of inflation, changes to pension plans, changes to Social Security benefits and Medicare that will affect the amount of supplemental retirement income you will need. As your estimated retirement income changes over the years, you can adjust your retirement savings number accordingly.

Don’t forget inflation

When estimating your retirement income, consider inflation.  It’s not how much income you will need the day you retire, but how much you will need ten, twenty, and even thirty years down the road.  During your working life, you have received periodic merit and cost of living raises that insulated you from the cost of inflation   In retirement, you will live on a fixed income.  With each passing day, your cost of living will increase while your income remains the same.  There may be cost of living increases to Social Security, but these have proven to be far from adequate to keep up with inflation.

You must be proactive and plan for inflation in retirement so you have the assets necessary to generate enough income to offset the effects of inflation during your retirement years.  Use the rule of 72 to quickly determine your cost of living in the future.  Divide  72 by the rate of inflation and that will tell you how many years it will take to double your cost of living.  For example, with a 2% inflation rate, it will take 36 years for your cost of living to double (72 divided by 2).  At a 3% rate of inflation, your cost of living doubles in 24 years (72 divided by 3).

Retirement calculators can help 

Retirement calculators can help you estimate the retirement income you will need and how much money it will take to generate that income while accounting for inflation and taxes.  Here are some calculators to try: Bankrate Retirement Income Calculator, Bankrate Retirement Planner Calculator, The Real Deal Retirement Toolbox (numerous retirement calculators).

Rosa and I have always thought of savings in terms of the income it could produce and it has served us well.  Of course, our goal from the beginning was financial independence which required income to replace wages.  Most people equate retirement with financial independence and they are correct in doing so, but only if they have enough retirement income to support themselves without working in retirement.  It is all about income, so target retirement income when determining your retirement savings number.

K. C. Knouse is the author of True Prosperity: Your Guide to a Cash-Based LifestyleDouble-Dome Publications, 224 pages