By now, you've probably amassed a decent sum in your retirement accounts and another hefty sum in the college fund. You haven't? Join the club. A survey conducted in 2009 by Edward Jones, the financial services firm, showed that 20% of respondents ages 45 to 54 had saved nothing at all for either retirement or college. A recent survey showed that 62% of respondents had never heard of a 529 savings plan, much less contributed to one.
Here's the penalty for procrastinating on both those fronts: If you had started saving for retirement in your twenties, you would have had to carve out 13% of your salary every year to replace your income in retirement, according to an analysis by T. Rowe Price. Now, at 45, you'll need to sock away 29% of your salary to catch up. (And if you put it off until age 55, you'll need to save 43%, which won't leave you much for groceries or gas.) Uncle Sam gives the procrastinators of the world a powerful incentive to save: Once you're over 50, you can contribute significantly more to your 401(k) plan than your younger colleagues.
Adjust the college plan. The same time-and-money crunch applies to college savings. Compare the difference between starting a college fund when your child is a toddler and when he or she is 13. Fifteen years out, you would have had to save $345 a month to cover 75% of the cost of a public college education, according to Savingforcollege.com. At this stage -- say, five years out -- you'll have to save $646 a month, almost twice as much.
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Rather than regret the past, recalibrate. If you're on track for retirement but short of your college goal, for instance, you can always redirect 1% or 2% of your gross income from one pot to the other for a few years, says Greg Dosmann, a principal at Edward Jones. Recognize that you might have to work a year or two longer before retirement or boost the retirement allocation after you're done paying the college bills. "It's a trade-off," he says.
Or consider borrowing -- judiciously. Parent PLUS loans, sponsored by the federal government, carry a fixed 7.9% rate. PLUS loans let you borrow up to the cost of attendance, minus any financial aid. Thanks to their fixed rate and consumer protections, such as forgiving the loan if the student dies or becomes disabled, PLUS loans are generally a better bet than private student loans.
Remember, however, that borrowing on behalf of your student can jeopardize your own financial security in retirement. If the gap is a chasm, not a crevice, find a cheaper school. Another way to get cash for college is to borrow against the equity in your home. With a home-equity loan, you pay a fixed rate (recent average: 6.4%) but borrow the entire amount upfront. With a line of credit, you pay a variable rate (recent average: 5.1%) and borrow as needed. With both, you can generally deduct the interest on amounts up to $100,000, no matter how you use the money.
A lower rate and tax-deductible interest may beat student loans. The downside to this strategy is that it pushes off a key goal for many people, which is to enter retirement mortgage-free. "After the kids are finished with college, you are going to have to save like heck to pay off the mortgage or, if you can't do that, sell the house and downsize when you retire," says Yrizarry. Downsizing doesn't have to be a bad thing, but it's a decision you should make before you borrow, not after.
Talk turkey with your kids. No matter how you plan to pay for college, let your kids know what you're prepared to do before you make up a college wish list. Be clear that "if the net price after financial aid doesn't end up at your number, it has to go off the list,” says Fox. Without that conversation, you'll be hard-pressed to say no when the acceptance letter from Vassar comes. "College is not just a financial decision," says Fox. "There's a whole emotional side. You have to have the guidelines established before you get to that point." (See 7 Pitfalls to Avoid When Paying for College.)
Invest what's left. If you're among those who have college covered (or don't have college costs to contend with) and you save the max in your retirement accounts each year, you may be looking for ways to invest excess income. One option is to add tax-free municipal bonds to your fixed-income allocation, says Yrizarry. Despite recent reports, most state and local governments have shown resilience in the face of budget cuts (see What Municipal Bond Investors Need to Know About Recent Local Bankruptcies).
Or take advantage of low interest rates and bottoming housing values to invest in real estate, Yrizarry suggests. If your student is heading off to college, you can accomplish multiple goals (and take advantage of a strong rental market) by buying a condo near campus and letting your kid and a few roommates live in it. Later, you can rent the property to other students or to alums during big sports weekends, generating income before and into your retirement.
This article first appeared in Kiplinger's Personal Finance magazine. For more help with your personal finances and investments, please subscribe to the magazine. It might be the best investment you ever make.