On paper, the path to retirement seems so simple. We save, invest for the future, and plan how we'll spend our money after we retire. But, the path we take rarely ever leads us in a straight line. Life itself is throwing us curveballs all the time. The loss of a job, an unexpected medical cost, and starting a family are all major life events that can throw your perfect plan for a loop.
College costs are a killer
One particular wildcard we could include among "major life events" is the rising cost of going to college. According to the College Board, the average cost of tuition and fees at private colleges in 2015-2016 was $32,405. Over four years, the average private college student would be staring down nearly $130,000 in expenses. Average public university tuition costs were a little lower, but by how much depends on whether or not you attend a school in your home state student. Out-of-state students paid an average of $23,893 in 2015-2016, while in-state residents at public colleges forked over an average of $9,410. This works out to a four-year cost of nearly $96,000 and close to $38,000, respectively.
These numbers by themselves are high. What makes them especially scary is that college tuition inflation has a long track record of handily outpacing both wage growth and the national rate of inflation. Based on data from FinAid, a website devoted to delivering accurate financial aid information to college students, tuition inflation is averaging about 8% per year, and over any 17-year period between 1958 and 2001 tuition inflation has outpaced the national rate of inflation by a factor of 1.2 to 2.1 times.
3 in 5 parents are making this big retirement mistake
A recently released report from HSBC of parents around the world who have children in college or soon to be in college highlighted the lengths parents go to in order to give their children the opportunity to earn their degrees. Results of the survey showed about 60% of those parents began saving for their children's higher education costs before they even reach primary school. Nearly 1 in 6 parents started the planning process before their children were even born!
Unfortunately, as HSBC's findings showed, that early planning doesn't necessarily translate into being totally ready when the time comes.
Results from HSBC's survey showed that 61% of parents with college-age kids are forgoing saving for retirement in order to pay for their child's education out of their day-to-day income. Some 58% of such parents said that paying for their child's college is making it difficult to meet other financial obligations, such as their mortgage. HSBC's study pinned $14,678 as the amount U.S. parents spend per year on their child's college education, which is nearly double the global average.
HSBC's report also brings up two additional surprises. For starters, 43% of the 6,200+ parents questioned expected their child to pay for some portion of their college expenses, but only 37% of their kids were actually doing so. Additionally, the costs of college extend well beyond tuition and fees for a majority of parents. Almost three-quarters were also paying for their child's insurance, more than two-thirds were paying for their cellphone or internet, and 63% of parents are paying for their child's textbooks.
The simple message from HSBC is that parents' long-term planning is not working.
You can't take a loan against your retirement
Perhaps the bigger worry is the 37% of parents who believe their child's education is more important than their own retirement. However, paying for your child's education at the expense of your own retirement is about as bad a decision as one can make.
Plain and simple, your children can take out student loans for their education, and they'll have plenty of time to pay off those loans. Those college debt balances might seem daunting, but with decades-long careers during which to pay them off, they aren't impossible to overcome.
On the other hand, parents who are presumably 20 to 40 years older than their college-age children have much less leverage with regard to time before they retire. Since you can't take out a loan to pay for your retirement, parting ways with money you know you'll need for your own living expenses is simply not a smart move.
For example, let's imagine that a parent has 45 years in which to save for retirement between ages 20 and 65. If, when their child goes to college, this parent routes all of the money previously destined for a retirement account in paying for those immediate expenses instead, they would lose four (or more) years of building up their nest egg. If the child goes to graduate school, make that eight years of savings lost (or more).
Do this instead
So how do you effectively plan for your child's education and/or lower your child's college-based expenses. Here are a few ideas to consider.
First, when deciding on the right college, take the long-term return on investment into account. PayScale publishes an annual list that ranks more than 1,000 colleges based on their ROI. In effect, it looks at the average four-year cost to attend each college, and then the average earnings over a 20-year period for its graduates. A higher ROI would be preferable.
What you'll learn from PayScale's data is that prestigious, high-cost colleges don't always have the best ROIs. In fact, sometimes in-state public colleges can offer the best returns. As a parent, you should encourage your child to examine these potentially cost-effective in-state options.
Secondly, the disparity between those who planned for their child's post-secondary education (60%) and those who are paying for it out of pocket (61%) shows that there's clearly not enough follow-through on the part of parents with their plans. There are two possible ways to fix this.
One solution is to have more budget accountability. A 2013 Gallup poll found that only 32% of American households were budgeting on a monthly basis. Many parents may simply not understand their cash flow and, thus, fail to optimally save for their own retirements and their children's educations. Having a working budget, which can be drawn up entirely through online software, could add the savings accountability that I'd be willing to bet many parents are missing.
My other suggestion to help parents keep themselves accountable is to meet with a financial advisor on a more regular basis. People's incomes and lives change quite frequently, so waiting five or 10 years to look over your plan with a financial advisor is simply too long. Consider meeting your advisor once or twice annually to ensure your saving goals remain on track.
Finally, strongly consider allowing your children to take out student loans to pay for their educations. Unless you've already met your retirement goals, it's unwise to part with money you may need later. Foregoing saving for your needs in favor of your child's education can mean missing out on much more by retirement.
Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
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