Saving for Retirement and College at the Same Time

How to Grow Your Own Money Tree - Quicken Loans Zing Blog That’s right. You read that headline correctly. I’m saving for both retirement and college – my two-year-old daughter’s college. Because I had my daughter so late in life (in my mid-40s), right about the time she’s going to be putting her cute little hands out for some college money, I’ll be getting ready to retire.

That’s the plan at least – and I’m sticking to it for now. Here’s how.

Saving for Retirement with a 401(k) Plan

I’ve been putting money into a 401(k) for years. I need to; it’s the only retirement I have. If I don’t save now, I’ll be living off Social Security, which doesn’t sound like a good idea to me. A good idea is to have a nice nest egg saved away that will supplement Social Security. And I’m doing that by putting as much as I can into a 401(k) each year.

That brings up the question, what exactly is a 401(k)? And why am I putting money into one? And how much am I allowed to put in? First, let’s look at the history of 401(k) accounts. According to NASDAQ.com, the 401(k) is named from a section of the Internal Revenue Code. It was, for the most part, “accidentally” created by Ted Benna, a benefits consultant who worked at Johnson Cos. Benna interpreted the law in a way that allowed him to set up tax-deferred accounts for Johnson Cos. employees and for matching employer contributions. Benna then worked with the IRS to change some rules of the law, and this eventually led to the huge popularity of 401(k) plans today (a replacement for traditional pension plans, which have all but vanished).

It’s pretty interesting that Benna didn’t really intend 401(k) plans to become the main way Americans save money for retirement, but millions of Americans do exactly that – including me. I’ve got a little bit socked away, and I plan on putting as much as I can into my 401(k) over the next 15 years or so. Right now, the maximum a person can put in tax-free is $17,500. Many companies, such as Quicken Loans, offer a match to a 401(k). The main concept is that once I’m taking money out of it (when I’m retired), my tax bracket will be lower and I’ll pay less tax on the money as I use it than I would pay at my current taxed rate. Remember, I don’t pay any taxes on the money I put in now. It’s a nice tax break and I see a significant drop in my total tax bill because of it.

The downside? My 401(k) is invested in the stock market and other financial markets. If those tank and go belly up, so does my retirement. That’s a scary thought, so some experts recommend converting a 401(k) to a less risky investment (such as Treasuries) at retirement age. There are all kinds of tax implications though, and it’s highly recommended to work with a tax professional when making those decisions.

Saving for College with a Roth IRA

Late last year, a financial advisor I work with recommended I start putting money into a Roth IRA for my daughter’s college fund. Apparently, money can be taken out of a Roth and used for educational expenses with no penalties or fees.

I can put up to $5,500 a year into my Roth, and in 16 years when my daughter is putting out her little hands for some college dough, I’ll have a nice little chunk of change to give her. Assuming I can afford to put in the money each year, I’ll have at least $93,500 (17 years x $5,500) saved for her. Add interest that will accrue over the next 16 years, and an assumption that the $5,500 cap will get higher, and the total could be closer to double. I hope so. My daughter doesn’t know it yet, but she hopes so too.

Keep in mind that unlike the traditional 401(k), a Roth IRA (or 401(k) if it’s through your job) doesn’t offer any immediate tax benefit, and any money put in it must come after tax. However, the good news is that since the money has already been taxed, you don’t have to pay tax on it when you take the money out. So, my daughter will get the full amount of cash to help her pay for her education. That’s a good thing.

What do you think? Are these good plans for retirement and saving for college? Any better ways out there to save for college? I’d love to hear them; I have 16 years to worry about it.

 

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