Save for College or Retirement?

These days, many parents can't afford both expenses at the same time.

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Many parents of teenagers are facing a financial dilemma: paying for their children's college tuition bills during the same years they should be shoring up their retirement accounts. Randi Mayer, 51, of Riverwoods, Ill., is currently prioritizing college savings. Mayer's 19-year-old older son attends a public university, and her 17-year-old son is considering public colleges as well. "Since college for us is more immediate at this point, probably a little bit more goes toward the college fund than towards the retirement fund," says Mayer, whose father financed her undergraduate degree. "I feel like college is now and it will be a while until we retire."

"For more and more people, these two big needs, retirement and paying for college, are happening at exactly the same time," says Greg Dosmann, 46, a principal with financial services firm Edward Jones. His own youngest child is 13. Less than a third (29 percent) of parents are saving equally for retirement and their child's college education, according to a telephone survey of 1,497 adults conducted recently by Opinion Research Corp. and Edward Jones. Among parents who can't afford to save for both, more respondents said they're saving only for retirement (22 percent) rather than just their child's college education (9 percent). And 26 percent of parents aren't saving for either.

Here's how to prioritize these savings goals:

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Maximize your match. Don't pass up your employer's 401(k) contributions, even to save for college. "I would rank retirement first and college second because there are other ways to pay for college," says Lynn Mayabb, a senior managing adviser for BKD Wealth Advisors in Kansas City, Mo. "There are no loans for retirement." A 401(k) match yields a greater return than you'll get on almost any other investment. Carl Wiley, 37, of Bayonne, N.J., says that saving for retirement is his primary goal. Each year, Wiley, who has a 5-year-old son and a 3-year-old daughter, saves enough for retirement to get the maximum 401(k) match, which is 4 percent of his pay. He is also preparing to start a shipping business. "With them being so little, college is really not even on our radar yet, even though we know it should be," says Wiley, who is production manager at a manufacturing company. "For now, it's just simpler to think about our retirement."

Check out 529 plans. Saving in a 529 plan allows a college fund to grow tax deferred, plus withdrawals to pay for college costs are tax free. Some states offer tax breaks if you invest in your home state's 529, but college savers can also shop around for the best plan in any state. Pay attention to enrollment, asset management, distribution, and maintenance fees to size up the best deal, and weigh the expenses against the state tax breaks. There are a range of investment options that carry different fees and expenses. Some states have prepaid tuition 529 plans that lock in today's tuition prices at specific colleges. But keep in mind that distributions from 529 plans that are not used for higher education expenses are subject to a 10 percent tax penalty in addition to income tax on the amount withdrawn.

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Consider a Roth IRA. Some retirement savers tap their nest eggs to pay for college. IRA distributions taken before age 59½ are exempt from the usual 10 percent early withdrawal penalty when they're used to pay for education expenses such as tuition, fees, and books. But traditional IRA withdrawals are still taxed as income, and Roth IRA distributions require taxes on the portion of the distribution that comes from earnings. Dipping into your retirement stash isn't necessarily the best way to pay for college. "If you use your Roth IRA for your kid's college, you lose the compound interest, and you can only make small new contributions each year," says David Hefty, a certified financial planner and chief executive of Cornerstone Wealth Management in Auburn, Ind. It can be difficult to regrow your former IRA balance because contributions are limited to $5,000 annually, or $6,000 if you are age 50 or older in 2009.