If you think being a good parent means providing your kids with a college education, you're not alone. But I'm going to tell you why I think you should think twice before you start saving for those tuition payments years down the road.
Sure, saving for your kids' college education is important. You've undoubtedly read articles and books on the subject. There's even a whole section of our website devoted to college savings, where we walk through the pros and cons of Coverdell ESAs and 529s and all the other ways to fund Junior's years among the ivy-covered walls. And here I am saying that most people shouldn't be doing it.
But bear with me. Before you wander off saying, "Hey, this guy's out of touch," let me tell you this: I've got three kids under 10, and if they follow the standard schedules, there will be two years when they'll all be in college at the same time.
I've given this one a lot of thought, believe me. So what's the scoop?
Here it is: You shouldn't save for your kids' college education until you've funded your own retirement accounts. And for those of us who haven't yet maxed out our retirement savings options, those -- along with all the other parts of getting our financial houses in order -- should take priority over saving for college. Since that's most of us ... well, you get the picture.
But why? Simple. You can get loans for college, but you can't get loans for retirement.
College lending has come a long way in recent years, with companies like First Marblehead (NYSE: FMD ) and Sallie Mae (NYSE: SLM ) at the vanguard of the revolution in private educational financing. But aside from a reverse mortgage, which requires free and clear home ownership and has substantial drawbacks, there really isn't any way to fund your retirement with loans.
My sense is that a lot of people -- particularly stressed-out parents in their 30s and 40s -- approach savings in a scattershot fashion: a little in the 401(k), a little in an IRA, a little in a 529, a little in next year's vacation fund, with contributions to each of those going up or down depending on the credit card balance and what seems most worrisome at any given moment. But as we all know, saving -- like most anything else -- works better if you have a plan. Here's a prioritized outline you can use to start yours:
- Pay off any credit card balances. This should be the first step in any savings plan -- those high interest payments will end up crushing anything else you do. See the Fool's Get Out of Debt Seminar for help if your balances are more than you can comfortably pay off in a few months.
- Set up a rainy-day fund. Put a few months' salary away in a low-volatility investment. It doesn't have to be a piggy bank, but it shouldn't be a biotech stock, either.
- Contribute enough to your 401(k) to collect your employer's match. That match is free money -- make sure you get it all.
- Fund your IRA. Whether you choose Roth or traditional, the increased flexibility and wide range of options make the IRA a better place for your next savings dollars than your 401(k). And note that a Roth IRA can serve as a rainy-day fund in a pinch, thanks to rules allowing you to withdraw contributions without penalty.
- Max out your 401(k). Maxing it out might be unrealistic if your employer's plan has very high limits, but you should be making sizeable contributions -- remember that the power of compounding means that, on average, a dollar contributed today will be worth more at retirement than a dollar contributed next year. Can you contribute 10% of your pretax income?
- Save for college. Now head on over to the Fool's college savings area for the full scoop on 529 plans, Coverdell ESAs, and all the other aspects of saving for your kids' education.
While none of us want to saddle our kids with debt right out of college, for most of us, the possibility of having to rely on loans for college is a better choice than the possibility of having to rely on Social Security during retirement. And if your college-age kids end up complaining about loans, tell 'em to be thankful that you won't need to move in with them when you turn 70.
If you'd like more help coming up with a plan for retirement investing, check out the Fool'sRule Your Retirement newsletter. It will tell you everything you need to know to set up a simple but effective strategy for your retirement investments -- and you can take a look absolutely free for 30 days.