With limited resources for saving, which is the most important financial goal -- saving for your retirement or saving for your child's college education?

While many parents want to fully pay for their children's college educations, the reality is that there are a variety of ways to save for that education -- personal savings, financial aid, and loans. Unfortunately, there aren't similar options for your retirement. No one is likely to loan you money if you haven't saved enough for retirement. You may want to maximize your retirement savings, realizing there are ways to use those savings to help with education costs.

How can that strategy help you when it comes time to send your child to college?

  • Your retirement savings won't be considered in financial aid formulas. The federal financial aid formula does not consider retirement accounts, including 401(k) plans and individual retirement accounts (IRAs), when calculating your expected family contribution.

    For other assets, the formula assumes that 5.6 percent of parents' assets and 20 percent of the student's assets will be used for college costs. Thus, you may actually increase your financial aid award by saving in retirement accounts instead of other types of assets.

  • You can still use these retirement assets to help pay for college costs.  Money in IRAs can be withdrawn to pay higher-education expenses before age 59 1/2 without incurring the 10 percent federal tax penalty, although income taxes will be assessed on the taxable portion of the distribution. If the money is withdrawn from a Roth IRA, your contributions can be withdrawn at any time without penalty or taxes, while earnings can be withdrawn before age 59 1/2 by paying income taxes but not the 10 percent tax penalty. With 401(k) plans, you typically can't withdraw the money before retirement age unless it is a hardship withdrawal, but you can borrow money if permitted by the plan. If you don't need the money to finance college costs, you can leave it in your retirement plans to continue to grow for your retirement.

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