Goal: Find a smart strategy for retirement and college savings.
4 Steps to Saving Responsibly:
1. Save 3-6 months of debt payments and other critical expenses.
2. Accelerate payments of high-interest debt so that the total debt you owe is decreasing every month, even if only slightly (meaning you are paying more than the finance charges).
3. Contribute 5% to your retirement account or the necessary amount to receive the employer match.
4. Contribute to college savings plans that offer a tax deductions (i.e. 529 plans on a state-by-state basis) without saving in the child’s name.
With college costs on an upward hike many parents are looking to education savings programs to stay ahead of the curve. In their eagerness to get a jump on education savings some parents may be overlooking other critical financial steps that also contribute to their family’s well-being. Before jumping on the college savings bandwagon make sure these other financial bases are covered in the slight chance your financial future doesn’t play out exactly as planned.
An emergency fund is the first priority. Depending on how many people are depending on your income this may range from 3 months of debt payments to 6 months of living expenses. Debt payments consist of minimum payments for student loan, car loan, mortgage and credit card balances. In the event you need to take a leave of absence or leave government service entirely, having debt payments saved in advance will enable you to keep your lenders happy and your credit score healthy. A healthy credit score is critical to getting rehired or borrowing what you may need once the emergency fund is exhausted.
Next, pay down your credit accounts enough so that the total debt owed is shrinking every month. Once the emergency fund is in place it’s time to face off with the credit card debt. Pay the most you can toward the debt with the highest interest rate and the minimum payments on other accounts. Low-rate credit card balances are not as urgent a personal finance priority but try to have it paid off before your child gets their own first card.
With an emergency fund in place and your high-interest debt being shown the door focus on retirement savings. Start by contributing 5% annually or enough to get the full employer’s match, whichever is greater. When it comes to college savings the mantra is “Retirement First!” There will always be student loans (don’t you know it) and ways to pay for school…but after graduation your kids may still need your help so you need to be financially strong enough to help them.
Once the first three bases are covered focus on setting funds aside in education-specific accounts such as 529 plans and Coverdell savings accounts.
Some states offer state tax deductions for 529 plan contributions and the proceeds may be used tax-free for higher education costs. While there is no federal tax deduction for 529 plan contributions there are also no income limits for plan owners. 529 plans also accommodate large lump sums allowing grandparents and other family members to fund education goals with one large contribution. Splitting education savings between a Roth IRA (in their name – not the child’s) and a 529 plan gives the parents more flexibility in when and how these funds will be spent.
“Retirement First!” offers parents greater opportunity to help children during their college years. If they have been saving for retirement for almost 20 years, parents in their peak earning years will be able to accommodate more tuition and living costs out of their monthly cash flow instead of requiring most of their income to jumpstart retirement savings. Parents may even choose to let the child undertake federally subsidized loans and make the monthly payments after graduation, building up the child’s credit score and offering them a tax deduction. Parents who save for retirement first hold sway over the kids, the schools and the IRS. And as any parent knows, any semblance of power over your children is worth its weight in gold.