Money dilemma: Nest egg or college

How two parents are trying to strike a balance between their children's education costs and retirement readiness.

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By Yuval Rosenberg, Money Magazine contributing writer

The Wilkes
Danville, Calif.
• Help their kids pay for college
• Retire in their mid-sixties
• $1,050,000 in home equity
• $540,000 in retirement accounts
• $10,000 in emergency savings
• $54,000 in education savings
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(Money Magazine) -- With three teenage children, Lorri and Bruce Wilke of Danville, Calif. are caught in the perfect parental spending storm. Between laptops, cell phones and clothes, the Wilkes seem to outgrow their budget the way kids outgrow shoes.

"You just feel like you're writing check after check after check," says Lorri. With Leah, 17, heading to college in the fall - and Dana, 15, and Carl, 13, soon to follow - the financial pressures are only going to grow.

The Wilkes have set up custodial accounts for each of their kids, but the $16,000 in Leah's name won't cover a year of expenses at the University of California schools she hopes to attend. Most of the couple's net worth is tied up in their $1.2 million home, so they must find a way to help their children pay for school without jeopardizing retirement.

"I don't want us to go broke saving for college, but I don't want to saddle the kids with debt," says Lorri.

Where they are now

Bruce and Lorri, who've been married for 20 years, live in a wealthy suburb of San Francisco. Bruce, 52, a construction project manager for the local school district, and Lorri, 48, a stay-at-home mom, earn around $100,000 a year.

But their money doesn't go that far in the pricey Bay Area. After paying the bills each month and setting aside $600 for retirement, they don't have much to add to their kids' accounts.

What they should do

Borrow against the house. There are no quick fixes to the Wilkes' college conundrum, says Sherman Doll, a financial planner in Walnut Creek, Calif. While Bruce and Lorri have $540,000 saved in IRAs, it's strictly for retirement. Relying on their home equity might not be ideal, "but it may be necessary," Doll says.

Doll recommends that the couple set a limit on how much equity to use. "If you finance the whole thing for all three of them," he tells the Wilkes, "you're going to dig yourself a pretty good-size hole for your own retirement." The Wilkes agree: They'll split the costs with their children.

Hypothetically, if the kids end up going to state schools in the UC system (and live on campus) their total costs could run more than $300,000. The parents couldn't borrow that much from their home without jeopardizing their security, Doll says. That's because they need the money saved in their home to help produce $70,000 of annual income in retirement.

If they were to reduce their equity by $300,000, they might not be able to do so safely. Plus they'd need to generate an even higher income to pay back the debt. Tapping about half that amount - around $150,000 is much more realistic.

Since the Wilkes have only 10 years and $144,000 left on their mortgage, Doll warns against refinancing into a new loan. On the other hand, a home-equity line of credit would allow them to borrow only as much as they need, when they need it.

Consider financial aid. While the Wilkes don't think they'll qualify for aid, they shouldn't rule it out, Doll says, especially since they'll soon have two kids overlapping in college. In addition to seeking out an aid adviser, he encourages the kids to apply for scholarships and work summer jobs to help defray some costs.

Play it safe with school savings. Doll normally advises saving for college through tax-advantaged 529s. But since the kids are older, he recommends sticking with the custodial accounts (transferring money out would force them to sell their holdings, triggering a tax bill).

Still, Doll says the accounts are being invested too aggressively. This is especially true for Leah. Because her tuition bills will start in a few months, Doll suggests the Wilkes shift her account - two-thirds of it is now in stocks - entirely into CDs or short-term bond funds like Vanguard Short-Term Bond Index (VBISX).

For Dana, who has three years until college, Doll recommends reducing her equity exposure from 90% to 30%. And only half of Carl's account belongs in stocks.

Fix their retirement plan. Doll also says Bruce and Lorri need to pay attention to their own retirement. He recommends the couple cut their equity stake from 80% to 70%. They also need to diversify - by reducing their exposure to large-cap U.S. stocks from 60% to 25% and by boosting foreign exposure through funds like Oakmark International Small Cap (OAKEX).

While Lorri is disappointed that there isn't a simpler solution to balancing college and retirement, "I feel like I have a little more direction," she says.

The makeover
  • Problem #1: The Wilkes want to help their kids pay for college but have few assets to tap besides their home.
  • The plan: Consider a home-equity line of credit, but set a limit on how much they intend to borrow for school.
  • The solution: This way Bruce and Lorri can take only as much of their home equity as they need for each child, when they need it.
  • Problem #2: Their children are nearing college age. Yet their school savings are being invested aggressively in equities.
  • The plan: Shift Leah's account into CDs and bonds. Invest their other two children's accounts more conservatively as well.
  • The solution: By doing so, the family will reduce the chance that these college funds will drop in value just as the kids start school.
  • Problem #3: The couple's retirement funds are concentrated mostly in one type of asset: large U.S. stocks.
  • The plan: Diversify that mix by also investing in bonds and foreign-stock funds.
  • The solution: This will reduce the potential for major losses if the U.S. stock market drops further.
  •  To top of page
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