“Believe it or not, you can handle your child's higher education costs and your 401(k) deferrals—you'll just have to start saving years in advance.”
A recent CNBC article, “Saving for college and for retirement isn’t impossible,” says that parents can fund college tuition and retirement if they begin saving as early as possible. And grandparents can help with well-timed tax-free gifts.
The cost of education is going to be highest for parents with younger children. For a couple today with a newborn, it’ll cost $455,585 to send him or her to a four-year private institution. But the cost of a public institution will be $202,768.
Let’s take a look at a hypothetical married couple. They’re 28 years old with a newborn, and they want to have a second child in a couple of years. The couple has been working since age 22 and earns a total income of $60,000. Their salaries are growing, and they’ve also been adding to their 401(k)s since they've started working and earning an average annual rate of return of 6.5%.
In addition, the couple’s been saving for college since the birth of their first child and they’re earning an annual return of 6%. They can accumulate $6.5 million by age 65 if they start saving 15% of their salaries in their 401(k)s at age 22. That deferral rate includes the couple’s 12% contribution and a 3% company match. When the first child is born, the couple (at age 28) can reduce their retirement plan savings rate to 12.2% and start to invest the difference or about 2.8% of salary into a 529 college savings plan.
After the second child arrives when they’re 30, they will continue saving to their 401(k), but at 9.4%. The difference (5.6% of salary) continues to go toward the college savings plan.
When the first child begins her freshman year of college and the couple turns 46, they can up their retirement plan savings to 12.2% and continue to fund the college plan. After the youngest kid starts college, the parents can go back to their original 15% deferral rate into their retirement plans. They’ll need to keep that level of savings until they retire at age 65. Plus, it’s an even better picture if grandparents help.
A person can make a lump sum contribution of up to $70,000 or $140,000 for married couples filing jointly to a 529 if the gift is spread over five years. Let’s say that grandpa and grandma make a $140,000 gift to the college savings account after the birth of the first child, the couple can continue deferring 15% of their salaries into their retirement plans. So when they hit retirement at age 65, they'll have $7.8 million in their 401(k) accounts.
It’s also important for the grandparents to know that gifting to the grandkids’ 529 lets them take advantage of the estate planning benefit.
But even with a solid savings strategy, fully funding four years at a private college for two kids is a pinch. In the past, guidelines suggest parents to use up to a third of their earnings to pay for college.
Reference: CNBC (November 7, 2016) “Saving for college and for retirement isn’t impossible”