As a parent, it can be tricky to balance saving for your child’s education and investing for your own retirement. As a general guideline, you should try to avoid dipping into your retirement savings to pay for college, for a couple of reasons:

1. Student loans typically come with a lower interest rate which means you may be better off financially to keep money invested in your retirement account and have your children fund college through low interest student loans.

2. Depleting your retirement savings to pay for college could put your financial future in jeopardy. Help your children with their college costs if you can afford it, but don’t if it means you won’t have enough for your retirement years.

College funding options

When it comes to paying for college your child may have a variety of funding options available to help them make it through their post-secondary education, including scholarships, financial aid, work-study and a part-time job.

While you may not be able to cover the entire cost of your children’s education, even a little help with educational costs may have a significant impact on reducing their student debt.

Manage debt

Here’s a hypothetical example to consider on managing debt.

Sally spends $100,000 to pay college costs over four years with a 5% interest rate loan—which is roughly in the range of interest rates charged by the U.S. Department of Education Student Loan Program.¹

• Loan amount: $100,000

• Interest rate: 5%

• Years to pay off: 30 at $540 a month

• Put away $25,000 ⇨ Save $50,000 in repayments
• Put away $50,000 ⇨ Save $100,000 in repayments

Tax-deferral plans

Here’s another hypothetical example of how a tax-deferred account could help.

Let’s say that you set up a tax-deferred savings plan and contribute just $1,000 a year—that’s less than $100 a month.

• If you earn a 4% average annual return on your investment, after 18 years, your college savings plan would have grown to about $25,650.
• If you’re able to save $2,000 a year (about $167 a month), with an average annual return rate of 4%, your savings would grow to about $51,300 after 18 years.

Tax-advantaged savings plans

Here are three popular tax-deferred education savings plans to consider:

• Coverdell Educational Savings Account (CESA) 

You may set aside up to $2,000 a year in a CESA for a designated beneficiary under age 18 to pay for qualified expenses² at an eligible educational institution, which can be either a qualified higher education or qualified elementary or secondary school.

Although the money you contribute is not tax-deductible, the savings within the account grows tax-deferred, and if the money you take out of the account is used for qualified educational expenses, it is tax-free. (See: Coverdell Education Savings Account to learn more)

• 529 Plans
  

These plans provide the opportunity to either pre-pay education costs or contribute to a tax-deferred savings account. Most 529 prepaid tuition plans are sponsored by state governments and require that you live in that state to be eligible.

Money contributed to a 529 savings plan is not deductible from your current federal taxable income, but earnings within the savings plan are tax-deferred, and some states may offer state tax benefits.

When you open a Prepaid Tuition Plan account, the money you contribute is converted to units or credits to be used for college and university education. When you open a Savings Plan, in addition to the contributions growing tax-deferred, they may be withdrawn tax-free if that money is used to cover eligible education costs for the beneficiary.

In addition, you may take up to $10,000 per year in tax-free withdrawals per beneficiary to pay for tuition expenses at private, public and religious K-12 schools. (See: How to choose a 529 Educational Savings Plan)

• Roth IRAs

This may be a more flexible option for parents who aren’t sure how much they’ll be able to contribute to their children’s education without severely curtailing their own retirement savings plan. While the Roth is a form of an individual retirement account, you can use funds from it to cover your children’s qualified higher education expenses.

While you normally would face a 10% penalty for withdrawing investment earnings beyond your total contributions to use for your retirement needs prior to age 59½, there are no penalties if you use the money for your children’s qualified higher education expenses (although you would have to pay income tax on your investment gains).

You can open a Roth and start contributing at any time as long as you meet the income requirements.³ (Learn more about the Roth IRA)

Scholarships & financial aid

Your child may reduce their student debt further through student aid programs, work-study programs, part-time off-campus jobs and a variety of scholarships that are offered through organizations geared to helping students pay some of their college costs.

One nonprofit organization, Scholarship America, offers a wide range of resources for students and their parents designed to help with educational funding. Visit the Scholarship America website to find a variety of options.

For instance, the site provides information on student funding opportunities in several key categories:

• About 50 corporations, organizations and foundations offer millions of dollars in scholarships for students in need.
• More than 1,000 “Dollars for Scholars” community organizations offer scholarships through financial partners and fundraising events.
• About 300 colleges, universities and post-secondary accredited institutions support the Dollars for Scholars program in a variety of ways.

The bottom line

You can save for your child’s educational costs and your retirement. It may require some sacrifice over many years, but if you start early, invest consistently and explore a range of options for scholarships and other educational funding, you can help your child without significantly undermining your own retirement plans.