Retirement or Tuition? It Shouldn't Be a Choice

Physician's Money Digest, September 2007, Volume 14, Issue 9

"If I had only done today what I set out for yesterday, I’d be free tomorrow." —Andy Munthe

62%—Approximate percentage of all full-time college students who receive grant aid. (College Board, 2007)

It's hard enough to save for the future. But it's even harder to decide whose future—yours or your children's? In a perfect world, there would be no choice. You could put enough away for a secure retirement while sending your children to the colleges of their choice. Unfortunately, the changing dynamic of retirement and the skyrocketing cost of a college education are making more physicians feel torn between these two priorities.

Let's consider retirement. People are living longer, pensions are nearly nonexistent, social security is nothing to rely on, and health care costs are exorbitant. Is it any wonder, then, that almost 45% of working-age households are "at risk" of being unable to maintain their preretirement standard of living in retirement, according to the latest National Retirement Risk Index by the Center for Retirement Research at Boston College?

The picture for college is equally daunting. Even after adjusting for inflation, average college tuition rose roughly 160% between 1977 and 2004, while average family income increased just 33% in the same period, according to reports. Within the past 5 years, prices have risen 35%, according to the College Board. Currently, total charges (including room and board) for in-state students at public institutions average $12,796; private 4- year colleges/universities average $30,367. Some say the total cost of a 4-year public university could reach nearly $32,000, and tuition and fees at private universities could double by 2020 if the growth rate continues.

A Financing Dilemma

Clearly, planning for just one of these life events requires real financial savvy. Planning for both retirement and college—which increasingly occur consecutively— may require a miracle. "As a parent, you want the best for your children, but most people don't have the ability to do both," comments Frank J. DeCandido, a Staten Island, New York–based CPA and Certified College Planning Specialist. "It's a tough choice."

Although it's tempting to put your children first, financial experts resoundingly agree that funding your own retirement should be the priority. Their reasoning is simple: No one is going to give you a scholarship, loan, or financial aid to help you through retirement. Yet despite this common sense, most parents put saving for college first. A recent study by the Vanguard Group and Upromise Investments Inc interviewed more than 1100 parents with children younger than age 18. It found that 37% said saving for college was their top financial concern, compared with 34% who ranked retirement as number one. The other 29% felt that saving for a house, car, or other major purchase was their most important priority.

Even wealthier families are looking for ways to reduce or avoid college costs, according to 99% of aid administrators in a study by AllianceBernstein Investments, Inc. One of DeCandido's clients, who owns his own company, is now taking $45,000 a year in Parent's Loans for Undergraduate Students (PLUS) loans to pay for college. The client has no real retirement or savings, his child doesn't qualify for needbased aid, and he has two younger children still to go.

Even those who have saved for retirement often find themselves sacrificing part of those earmarked funds to pay for college. According to AllianceBernstein, 62% of parents say that paying for college will significantly affect their retirement fund. Upromise reports that half of parents in a 2001 survey have tapped a 401(k) or home equity line. Yet "dipping into your retirement is absolutely the last resort," DeCandido says. "That is just a recipe for disaster." Overall, 70% of surveyed families do not have a financial plan that takes into account all of their financial goals, AllianceBernstein reports. "We're not saving enough, much less saving for retirement," DeCandido comments.

Plan Retirement First

Many experts, including DeCandido, advise that the first part of any total financial plan is that "physicians should max out as much as they can on their own retirement." In other words, take full advantage of the allowable annual benefits of any offered retirement plans. By law, physicians can save up to $15,500 in 2007 through 401(k) or 403(b) contributions. Solo 401(k) participants may be allowed to contribute up to $15,000 of their income and additional profit-sharing contributions as long as total contributions don't exceed $45,000 in 2007. For IRAs, it is the smaller of the following amounts: $4000 or your taxable employment compensation for the year. For savings incentive match plan for employees (SIMPLE) IRAs, it is $10,500 in 2007. And if a physician is older than age 50, additional amounts are allowable with nearly all these plans. A summary of allowable amounts, provided by the Financial Planning Association®, is available on the Web site of the American College of Emergency Physicians at www.acep.org/webportal/membercenter/careers/finplan/1106No2.htm.

While a physician's main sources of retirement income will most likely come from one or more of the above-named plans, additional funds may be necessary to maintain one's lifestyle. In this case, real estate, stocks, bonds, life insurance, deferred annuities, mutual funds, and the sale of a practice are all viable sources—although timing can be a factor with some of these options. Ultimately though, as DeCandido points out, the ways to fund retirement are limited.

Take Financial Aid into Account

Paying for college, on the other hand, allows more flexibility in terms of grants and borrowing. In fact, after grant aid and tax benefits are considered, actual net tuition and fees (not including room and board) drops from an average of $5836 to $2700 for public 4-year schools and from $22,218 to $13,200 for private schools, according to the College Board. This means students receive on average about $3100 and $9000 in grants and tax benefits, respectively.

Yet the forecast on obtaining such college aid contains both good news and bad news. Recent research has found that parents tend to overestimate both the cost of college and the amount of aid their children will receive. Obviously, the most desirable forms of aid are grants and scholarships that don't have to be paid back. According to the College Board, while total student aid increased by 3.7% to $134.8 billion from 2005 to 2006, federal Pell Grants, which are needbased, fell in both the total number of grants awarded and the amount of money received per recipient (on average, $120 less). Grants from colleges and universities, which can be need- or merit-based, accounted for 41% of the grants from all sources.

Beyond grants, DeCandido cautions that if a family's income exceeds approximately $75,000, a child is unlikely to qualify for financial aid at most public universities, and income of approximately $125,000 will disallow financial aid at most private universities, which leaves many students and parents borrowing more than ever before. In fact, the two non–needbased federal loans, the Federal Unsubsidized Stafford Loan (FUSL) and the PLUS, grew in number by more than 150% between 1994 and 2004.

While wealthier families may not qualify for needbased grants or financial aid, tax benefits favor middle- and upper-income families, according to the College Board. About 54% of the benefit of the federal education tax credits goes to higher-income taxpayers. Only 22% of the benefit of the tuition tax deduction goes to taxpayers with incomes below $50,000; 41% goes to those with incomes between $100,000 and $160,000. "There are a lot of things on a tax return that help you out," DeCandido comments.

Tapping All Available Sources

While common wisdom is to limit the income and assets in a child's name for financial aid purposes, DeCandido says physicians who are self-employed or own an S-corporation and whose child will not qualify for any need-based financial aid may want to have their child claim independence. If the child works for the practice, they can earn up to $37,200 out of the company's expenses and they may also qualify for loans and tax credits such as the helping outstanding pupils educationally (HOPE) scholarship and Lifetime Learning credit. "It's a tax-shifting exercise," DeCandido says.

Beyond grants, loans, and tax considerations, there are many other strategies that can help pay for college. Some include: tax-deferred savings plans like 529s and Coverdell education savings accounts; trusts; grandparent contributions; work study options; junior colleges for the first 2 years; and others. Keep in mind, "most kids out of high school have no idea what they want to do," DeCandido says.

Ultimately, you need to remember that a college education is a privilege. Your own retirement, on the other hand, is an inevitable reality. You won't be giving your child an advantage with a college education if you later become a burden by not funding your own retirement. And luckily, no matter how much you save for retirement, those assets in retirement accounts won't count against you on the federal college financial aid application. So talk to a financial advisor and devise a sensible plan that keeps both priorities in mind. DeCandido concludes, "The greatest asset a physician has is time, and they need to use that time to save for retirement first."

Watch Your Spending

While parents say saving for college is a priority, in many cases, their behaviors belie it. Most parents have spent more money on entertainment and/or discretionary purchases in the past year than they've saved for college, according to research from AllianceBernstein Investments, Inc. Specifically:

  • 58% have spent more on eating out or ordering take-out;
  • 49% have spent more on vacations;
  • 38% have spent more on consumer electronics; and
  • 31% have spent more on their children’s allowance.

Furthermore, 74% of parents admit they could be saving significantly more for their children's education if they limited money spent on traveling, entertainment, electronics, and impulse purchases. Two thirds acknowledge that by reducing their discretionary spending on items such as toys, clothes, and entertainment for their children, they would be able to save much more for their college educations. For more information, visit CollegeSavingsCrunch.com.