Source: Social Security Administration.
If there's one sure thing about your path to retirement, it's that it'll be different from all the others. Although we'd like to think of retirement as a shift from Point A to B -- completed in a straight line as expediently as possible -- life offers plenty of twists and turns along the way that force us to readjust our game plans. Starting a family, buying a home, unexpected medical bills, even college costs can alter our retirement trajectory.
But what if Americans are making a plain-as-day retirement error that could probably be easily corrected?
Parents bend over backwards for their kids
According to a new study from asset management company T. Rowe Price, parents are practically bending over backwards to ensure their children can go to the college of their choice. Data from the study shows that a whopping 57% of parents surveyed believe paying for their child's college education is more important than their own retirement -- that's up 5% from 2014, when T. Rowe Price last surveyed Americans across the country in 2014.
When asked how much debt parents were willing to take to get their children through college, slightly more than half (52%) affirmed their willingness to take on $25,000 or more. Almost a quarter of respondents (23%) were willing to take on more than $75,000 to get Junior his degree, and close to one in 10 said they'd borrow money if they had to in order to send their kids to college. Nearly half (49%) also pointed out that they'd be willing to delay their retirement in order to fund their kids' college education.
What's more, 30% of parents in the survey noted that they're using money from their own employee-sponsored 401(k) to fund an education for their child. Additionally, 15% admitted to funding their child's college education with money from a Traditional IRA, and another 13% said they were using money from a Roth IRA.
Source: Flickr user Nazareth College.
Why parents make this sacrifice
Why would parents do this?
To begin with, they want their children to have better lives, financially, than they did. By ensuring their children go to the college of their choice and get degrees, parents are trying to set their children up for long-term success and the potential to climb up the socioeconomic ladder.
As Pew Research Center data from February 2014 clearly demonstrates, a college education can make a world of difference. In Pew's study, a millennial aged 25 to 32 with a high school diploma earned a median of $28,000 annually in 2012 dollars. On the other hand, a millennial of the same age range with a bachelor's degree or better netted a median of $45,500 per year. Over 40 years, we're talking about a $700,000 nominal difference that, with a disciplined investment strategy, could work out to millions of dollars in outperformance for the individual with a college degree.
Source: Flickr user Reynermedia.
Secondly, as touched on above, a college degree has moved away from being an exception to being more of a prerequisite to landing a skilled job that pays well and allows room for economic advancement. To be clear, there are well-paying jobs that high school graduates can land, but they are more the exception than the rule. Getting a college degree can add versatility to a graduate's job options, and it can give them extra leverage when negotiating their salary.
Finally, more than three-fifths of respondents (62%) suggested that investing in their own child's education was an investment in their own retirement. Ensuring their child earns a college degree could mean they're no longer living at home and are able to take care of themselves. Financial independence for a child means potentially lower expenses for parents.
Why this is an egregious retirement mistake
However, the fact of the matter is that paying for your child's education at the expense of your retirement funds is almost always a horrible idea.
Time can be the greatest friend of an investor, or it can become his or her greatest enemy. Parents who choose to rob from their retirement funds in order to pay for their child's education are cancelling out the positive effect that time and compounding gains can have on their own nest egg, and in the process turning their greatest ally into their feared enemy.
For example, imagine a parent was able to start saving $5,000 per year at age 20, and assume this money earns 8% per year (the historical return rate of the stock market). By age 45, or 25 years later, our parent would have $433,614 in retirement savings based on Bankrate's return on investment calculator. If our parent continued to save and invest they would have $2.18 million come retirement by age 65.
Now, let's assume he or she took $100,000 out to pay for their child's college education at age 45. If this parent decides to retire at age 65, they would have just $1.51 million. It still sounds like a decent amount of money come retirement, but that simple decision to fund your child's education cost around $670,000 over the long run.
Source: Social Security Administration.
The important point for parents to remember here is that you can't borrow money against your retirement, but your child certainly can borrow money against their education. I'm by no means giving a thumbs-up to student loan debt, but when choosing between raiding your retirement nest egg and allowing your child to get a loan to get a college degree, the latter is almost always the smarter plan. The one exception here would be if you're well ahead on your retirement number and can actually afford to fund your child's education without hurting your chance of a comfortable retirement.
Another point parents will want to consider is that tuition price doesn't always correlate to return on investment. In other words, the most expensive colleges won't always yield the best-paying jobs. Research firm PayScale ranked more than 1,300 colleges around the U.S. based on their 20-year net return on investment totals by taking into account the salaries of roughly 1.5 million graduates. What PayScale's rankings demonstrated was that you could often get a solid return on investment from less prestigious colleges, thus saving money in the process.
There's nothing wrong with trying to help your children get ahead in this world, but the fact remains that raiding your own retirement funds to make that happen is bad news for parents and their kids.
