You should make these moves before you start funneling away money for tuition, says financial planner Kevin McKinley.
As graduation ceremony season nears its peak, I’m seeing a steady drumbeat of stories warning of ever-rising tuition costs and education debt loads. It’s no wonder many parents of smaller children are panicked into thinking they have to drop everything and start saving all their money for their kids’ college expenses RIGHT NOW. Hang on just a second there, moms and dads. Although I’m certainly in favor of getting parents to save, there are four things I’d suggest you should do—and one you shouldn’t—before making “saving for college” the top priority. (Already completed all of these steps? Check out the MONEY 101 section on college for help getting started on your college savings journey.) DO save for retirement Since it’s possible to borrow money to pay for college but not to fund retirement, working parents have to put their own needs first. You should start by putting money in any pre-tax retirement savings plans at work (such as a 401k or 403b), at least up to any available matching contributions from employers. If no employer-sponsored plan is available, those with earned income should fully fund an IRA. You may be able to make a deposit for a stay-at-home spouse, as well. You can save up to $5,500 in 2014, or $6,500 if you’re 55 or older. The tax savings on the contributions to a pre-tax retirement plan will likely exceed what the deposits to a college savings account are likely to earn, especially in the first year. Then if you end up with a well-funded retirement, you can tap their overstuffed accounts once you hit 59 1/2—and have passed the penalty zone—to pay for college expenses as needed or pay off student debt incurred by your children. DO open a Roth IRA For eligible depositors, Roth IRAs can serve as a hybrid college/retirement savings account. These accounts—which allow for tax-free withdrawals—are typically thought of as a retirement savings vehicle. But if parents want or need the money before retirement for college (or other) costs, they can withdraw the Roth IRA contributions at any time for any reason with no taxes or penalties whatsoever. As an added bonus, money held in parents’ retirement accounts is less likely to be counted in a school’s need-based financial aid calculation than funds in the child’s name. DO pay off credit cards Double-digit interest rates charged on outstanding balances—the average APR is now around 16%—usually greatly exceed what you’d earn on your money elsewhere. So you’re better off erasing your debt before putting a lot of attention toward college. Plus, an improved credit score will make it easier for you to obtain higher education loans for your kids should the need arises in the future. DO prepare for the worst The majority of parents of younger children haven’t established wills, guardians, and other necessary legal steps—much less purchased enough life insurance to ensure that the tragic death of a parent will only be an emotional nightmare, and not a financial disaster as well. Moms and dads should see lawyer as soon as possible, and plan on spending a few hundred to a few thousand dollars, depending on the complexity of the situation. You should then purchase enough term life insurance to cover all future expenses—including college—that the survivors might endure. DON’T pre-pay the mortgage Well-meaning parents often try to pay down their housing debt as quickly as possible, thereby saving interest expenses and freeing up money that would otherwise go toward the monthly mortgage payment. But that step should only be considered if the parents are ahead of their retirement savings schedule, have no other debt outstanding, no future major expenses on the horizon, and have at least a year’s worth of living expenses saved up. Those parents who don’t meet these criteria should stop paying anything extra on their mortgage until they have fulfilled the other aforementioned financial obligations. Otherwise, parents could end up house-rich and cash-poor—just when it’s time to pay for their kids’ college expenses and their own retirement. _____________________________________________________ Kevin McKinley is a financial planner and owner of McKinley Money LLC, a registered investment advisor in Eau Claire, Wisconsin. He’s also the author of Make Your Kid a Millionaire. His column appears weekly.