College? Retirement? How to handle two big financial challenges
It's difficult to save for two major expenses like retirement and a child's education - how can you do it without being completely strained?
NEW YORK (Money) -- My wife and I recently bought a home and are now looking into getting a jump on saving for retirement and for our son's future college tuition. But we're unsure what to do first.
We have a little over $100,000 in our 401(k)s, but little savings beyond that. I think we should build an emergency cash fund first to tide us over in case we're hit with unexpected expenses. But my wife thinks we need to open a 529 account for college tuition?
What do you think? Is it possible to do both and not be too strained?
-- Wayne Peterson, Randallstown, Maryland
ANSWER: Is it possible to save for retirement and for a child's education at the same time? Sure, but it requires a pretty decent income and lots of disciplined saving. And even then it's no picnic.
Indeed, as a practical matter, I think most people have enough trouble just saving adequately for their retirement. Throw in college education and it just becomes too overwhelming. Too often the result is that people don't address either goal adequately, or they get so discouraged that they sometimes give up altogether, figuring it's hopeless.
That's why I recommend that people avoid trying to do too much and, instead, adopt a realistic saving plan that focuses on the most important goals first and then moving on to secondary ones.
So which goals are most important and which are secondary? Well, ultimately that's a personal decision. But if you look at this issue in terms of what strategy has the best overall chances of securing your family's current and future financial security, I think the following three-step approach makes sense for most people.
Have an emergency fund First, build a cash reserve, or emergency, fund. Here, I'm talking about having about three month's worth of living expenses in a very safe and readily accessible account - a money-market fund, savings account or perhaps an ultra-short-term bond fund, something with an average maturity of no more than two years.
The idea is to have a buffer that acts as a first line of defense against financial setbacks, a stash you can fall back on to cover unexpected expenses you can't fund out of your paycheck or to carry you until you find a new job in the event you're laid off.
Some people say this fund should hold as much as six months' expenses. The only problem I have with that is that putting together that sort of cushion can be so challenging for some people that they never make it, and then might not get around to saving for other goals.
You can give yourself a bit more wiggle room by opening up a home equity line of credit that you could tap when your emergency fund is on the verge of being tapped out.
Put as much as possible in retirement accounts After you've got your emergency reserve funded, start plowing as much as you can into your 401(k) or other retirement savings plan.
You, apparently, have embarked on this part of the plan before accumulating the emergency stash. I think it's better to do it the other way around, or, if you can manage it, build your cash reserve fund as you save at least something for retirement. But the most important thing is that once you've got that cash reserve together, you want to fatten up those retirement accounts.
Ideally, you want to contribute at least enough to your 401(k) to take full advantage of whatever match your company offers. But if you really want a shot at a comfortable retirement, probably shoot for socking away 10 percent to 15 percent of your salary in your 401(k).
If that's more than your plan allows, then do the max and try to make up the rest by opening up an IRA or even a taxable mutual fund account.
If you get started early enough - say, in your 20s or early 30's - contributing this amount should give you a good shot at an income that, combined with Social Security, should fund a comfortable lifestyle in retirement. If you don't get started until your 40s or later, however, you should try to ramp up your savings even more.
You've already accumulated $100,000 in your 401(k). That's great. But without knowing how old you are and how much income you'll need to live comfortably in retirement, I can't really say whether that hundred grand, combined with however much you save for retirement on a regular basis, puts you on track.
Any financial adviser should be able to crunch the numbers so you can assess your progress, or you can get a sense of whether you're on the right path by going to an online calculator such as our Retirement Planner tool.
Only then comes the rest Once you know you're on track for retirement, you can start to think about other goals, such as saving for a child's education. I put this goal behind retirement not because I don't think it's important. Rather, it's a question of options.
Unless you think you can get by on Social Security - which I think one look at the Social Security administration's benefit calculator will reveal as wishful thinking - your only hope for a comfortable retirement these days is to save rigorously throughout your career.
There's really no other way to do it.
With college expenses, on the other hand, there are several alternatives. Your kid may qualify for financial aid. You may be able to hit up the grandparents for help. Students can earn part of their tuition, or take out college loans. You could borrow against your home equity. You could even dip into your retirement accounts or other savings if you really, really need to.
So given the many options for paying for college and the fact that you're largely on your own when it comes to funding retirement, I wouldn't start a 529 savings plan or any other type for that matter until I was reasonably certain that I had my retirement savings under control.
Call me a Scrooge. But I think it makes more sense to send your kids to a less expensive school if necessary or saddle them with some loans rather than pay for their education if doing so means they might have to support you in retirement because you never saved enough. In any case, that's the way I see it.
Enhance your family's current financial situation by building a reserve fund and then set the stage for your future financial security by saving for retirement. If you can still manage to after that, then do whatever you can for your kids' education.
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