As Americans we spend the vast majority of our working lives saving for our future and retirement. But, there are life-changing events that come along from time to time that change our priorities. Buying a home or a car is a good example, but there is perhaps no greater life-altering (and money-diverting) event than starting a family.
Parents open up their wallets for their child's education
According to U.S. Census data from 2014, there are approximately 35 million married couples in the U.S. who have children, as well as 11 million single-parents with children. This means there are literally tens of millions of working adults out there willing to sacrifice everything, including their money and savings, to ensure the well-being of their child or children.
It's a natural instinct to want to protect your children and ensure they have equal or better opportunities than you had growing up. Perhaps this is why so many parents these days are willing to sacrifice a portion of their savings or retirement nest egg in order to pay for their children's college education.
A new study released at the end of September by LIMRA Secure Retirement Institute, which interviewed close to 1,000 Americans over the summer, showed that around a third of respondents either already have reduced (11%), or would be willing to reduce (22%), what they've been saving for retirement in order to pay for their child's college education.
Furthermore, one in 10 respondents has withdrawn money from their nest egg to help pay for a child's college education, while another two in 10 said they'd be willing to. Lastly, LIMRA discovered that nearly four out of 10 respondents would delay their own retirement or work into their golden years in order to put their children through college.
Why college is so vital
Why such a push to send children to college? Two primary reasons.
To start with, over the last couple of decades we've seen a major shift in the jobs market. A college degree has become something of a requirement if you hope to have the opportunity for socioeconomic advancement. A Pew Research study from February 2014 showed that millennials aged 25 to 32 with only a high school diploma earned a median of $28,000 per year, whereas a millennial of the same age range with a four-year degree (or higher) netted a median of $45,500 per year (in 2012 dollars). This $17,500 annual difference equates to $700,000, nominally, over a 40-year period, and could become a difference of millions of dollars inclusive of investments over that same time span.
The other issue at play here are college costs. The cost of a college education is rising at an exceptionally fast pace, handily outpacing the rate of inflation. Data from the U.S. Department of Labor shows that between 1985 and 2013 the Consumer Price Index (the standard measure of inflation) rose by 121%. College tuition costs, on the other hand, catapulted higher by 538%. Making matters worse, wage growth has more or less tracked inflation, making it ever tougher to send kids to college. But, given the monetary difference noted by Pew, going to college has proven to be a near-necessary step for today's kids.
This selfless act could be killing your retirement
It's only natural to want to take care of your children by sending them to college. But, paying for their education at the detriment of your own retirement savings, or out of your nest egg, could prove disastrous.
There's one fatal flaw with the idea of parents paying for their kids' college education. A child can take a loan to pay for their college education, and he or she will likely have 40, 50, maybe 60 or more years to not only become debt free, but to build wealth on their own. Parents, on the other hand, can't take out a loan against their retirement. Handing over money to their children that's been set aside for their own retirement eats into their shrinking opportunity to use time and compounding to their advantage.
Let's look at a hypothetical case in point.
Based on the 2014-2015 academic year, the average cost for a "moderate" (i.e., median) college budget according to the College Board was $23,410. Annualized over four years and taking into account tuition inflation, it's possible the average college entrant could rack up $100,000 in tuition costs and fees for a four-year degree.
On the flipside, let's imagine two parents have been socking away $4,000 ($2,000 each) annually for the past 20 years, and are both age 45 when their child heads to college. Assuming an 8% rate of return (8% is the average rate of return, historically, for the stock market), our fictitious couple would have $216,000 when their child heads off to college.
Now, let's assume we remove $100,000 to pay for their child's college education. Assuming both work to age 65, they'll have a combined $648,400 upon retirement.
Now, let's assume that our fictitious couple didn't give any money to their child for his or her college education, and that the child instead took out a student loan. Keeping that $100,000 in their nest egg and continuing to add $4,000 per year at an 8% annualized return rate until age 65 yield's a little more than $1 million for the couple. Over just a 20-year period the original $100,000 had cost these fictitious parents more than $350,000 in potential retirement savings.
With rare exception -- such as if you've more than met your retirement number -- paying for your child's college education out of your retirement savings or nest egg is a bad idea. It's also not necessarily a smart move to assume you can delay your own retirement by working longer since our health can be unpredictable, and our employers may not keep us around that long. The smartest move you can make is to allow your child to take out a student loan to pay for his or her education.
But, even here there's an opportunity to reduce the long-term costs associated with a student loan. A high-cost four-year institution doesn't always mean a student will get a great return on their investment. Occasionally lower-priced state universities or specialty trade schools can offer bigger returns on investments. I'd encourage parents and their kids to look for possible alternatives within their state that have lower tuition fees and expenses, as it could reduce the total amount of loans a student graduates with.
Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
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