Most parents want to provide as much as possible for their kids. But between summer camps, private schools and college, parents sometimes overextend themselves, putting their retirement savings on the back burner. Juggling multiple financial goals can be difficult.
For many families, there’s a gap between covering the required basic monthly expenses and the additional income needed to fulfill other financial goals — such as retirement contributions or a college fund. As a financial advisor, we often stress to clients the importance of paying yourself first.
Kids are expensive. It is easy to understand how parents are forced to make some difficult decisions. The U.S. Department of Agriculture estimates that a baby born in 2013 will cost middle-income parents roughly $300,000 until age 17, accounting for inflation. The study defines middle-income as households earning approximately $61,000 to $106,000 per year. Families that earn more can expect to spend more than $500,000 until age 17. Note that this projection excludes higher education.
According to the National Center for Education Statistics, it costs about $100,000 to send a child to a four-year public university, and nearly $200,000 for a private four-year school. Even for new parents with the benefits of a longer time horizon, the savings required to cover private college tuition is projected to be more than $800 per month. The inflation rate for education is higher than inflation as measured by the consumer price index, which eats into investment returns.
‘I have decades to save for retirement.’ While this is probably true, it is actually an even bigger reason to start saving for retirement today. By paying yourself first, your invested contributions will work harder for you over time through compounding. JP Morgan Chase & Co. provides an example of the effects of compounding:
— Investor A saves $5,000 annually between the ages of 25-35. Assuming a 7 percent annual return, by age 65, Investor A has an account balance of more than $1.1 million.
— Investor B gets a late start, and doesn’t begin saving $5,000 annually until age 35. Investor B contributes for 30 years, until age 65. Assuming the same 7 percent annual return, Investor B’s account balance is only $560,000.
Even though Investor A contributed $100,000 less than the late starter, they still achieved nearly twice the return due to the power of compounding. Younger investors with a longer time horizon until retirement can typically take a more aggressive approach to their asset allocation. Although your allocation will depend on your goals, age, risk tolerance and so on, starting out with a more aggressive approach can often add to the benefits of compounding in the long term.
Find a happy medium. Even when finances are tight, there are several strategies you can use to make the most out of your income:
— Pay yourself first — before even looking at your after-tax cash flow, make sure you are making sufficient contributions to your employer’s retirement plan or individual retirement account. Generally, people in their 20s and early 30s should be contributing at least 10 percent of their gross income annually to qualified retirement plans, or up to the maximum $5,500 IRA contribution (in 2015).
— Start a college savings plan such as a 529 plan — after-tax contributions are made and grow federal tax-free. When the funds are used for qualified education expenses, there is no tax on the deferred investment growth, either. Friends and family can also contribute to your 529 plan, which can be a great gift idea for special occasions.
— Consider the alternatives — whenever facing conflicting financial priorities, weigh the availability of alternatives before dedicating funds to any one bucket. For example, even you aren’t able to cover 100 percent of your children’s college expenses, plenty of alternatives exist to bridge the gap. Merit scholarships, independent scholarships, work-study programs and federal loans can all help families achieve their goals. There are no loans for retirement.
Although it can be hard, parents should always try to put themselves first when it comes to saving for retirement. Today, many offspring are returning to the nest post-college. With an increasing number of young adults still requiring some support until age 30, new parents can’t afford to delay saving for retirement, as it may take longer than anticipated for kids to be independent.
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Pay Yourself First: Save for Retirement, Then College for the Kids originally appeared on usnews.com
