June 29, 2015

Don't let student loan debt hurt your retirement savings

June 13 was a big day in my household. It was the day when my son donned his cap and gown, and “walked” with the graduating class at California Polytechnic State University in San Luis Obispo, Calif. With just one class yet to complete, he'll be receiving his diploma in aerospace engineering in December.

As he closes in on completing his degree, my husband and I will reach a very satisfying milestone too: we're about to make our last tuition payment!

When we talk about the cost of college education and student loan debt, we often talk in terms of rising tuition rates and the total amount of money borrowed by recent graduates.

We do this for good cause: the cost of college is becoming unaffordable for too many students, and the average amount of debt is a crushing burden for our youngest workers. In its ninth annual report on student loan debt, the Institute for College Access and Success found nearly 7 in 10 graduating seniors in 2013 left school with an average of $28,400 in student loan debt, an increase of 2 percent from 2012.

Rarely do we talk about the student loan debt shared by parents. But we should, because it's significant.

Since 2005, student loan debt levels have more than tripled among those ages 50 to 59 and more than quintupled for borrowers ages 60 and up. Currently, the average student loan balance for borrowers ages 50 to 59 is $23,183. Those ages 60 to 69 are only doing slightly better, with average loan balances of $19,225. According to the Federal Reserve Bank of New York, nearly 17 percent of outstanding student loan debt is held by borrowers age 50 or older.

The fact that parents want to help their children is a good thing. A college education is important to creating opportunities for a fulfilling career and financial independence. However, it is vitally important that parents balance their desire to fund their child's education with their savings goals for retirement. The best way to do this is to plan and start saving early.

I cannot stress strongly enough the need to start saving early… partly, because you may need more than you think. My oldest son went to school locally, which made tuition more manageable. But when my younger son chose to study out of state, we were faced with costs that were roughly three times higher than local tuition, in addition to elevated living expenses and the cost of visits home.

We planned and saved, and that was enormously helpful. Here are some strategies that can help any parent.

Here are some options

When planning to fund your child's college education, several plans can help you achieve your goals. Two of the more popular are 529 College Savings Plans and Coverdell Education Savings.

529 Plans come in two types: College Savings Plans and Prepaid Tuition Plans. These plans are state run and each state has its own version. While 529 plans are included on the Free Application for Federal Student Aid (FAFSA), they have relatively little impact on financial aid eligibility because they are the parent's asset.

College savings plans let you save money for college in an individual investment account. When you contribute to the account, you typically choose one or more portfolios offered by the plan. The underlying investments of these portfolios are exclusively chosen and managed by the plan's professional money manager. But keep in mind that college savings plans don't guarantee a return. If the portfolio doesn't perform as well as you expected, you may lose money.

A prepaid tuition plan lets you prepay tuition expenses now for use in the future. The plan's money manager pools your contributions with those of other investors into one general fund. The fund assets are then invested to meet the plan's future obligations (some plans may guarantee you a minimum rate of return).

529 plans — both versions — offer federal and state tax-deferred growth and federal tax-free earnings if the money is used for college.

The Coverdell Education Savings Account (ESA) is an account where up to $2,000 per year per beneficiary can be saved. Amounts contributed to the ESA grow tax deferred and are tax-free distributions if used for qualified education expenses for both K–12 education and college education. Contributions must be made by April 15 following the contribution year. However, the ability to contribute is phased out for joint filers (single filers too) with modified adjusted gross income (MAGI) between $190,000 and $220,000.

Tips for getting financial aid

All families, regardless of income, should complete the FAFSA, which is the form that determines college students' eligibility for financial aid, including loans, work study, grants and scholarships.

You can employ several other tactics that may help you meet the challenge of funding your child's education. For example, since permanent life insurance with cash value is not included as an asset on the FAFSA, some families use this as a way to decrease “included” assets. The cash value can also provide a means of tax-free distributions for education costs.

Other tips include:

• Keeping account ownership in parents' names, rather than the student's.

• Monitor your investments and try to minimize gains from the sale of assets during the tax year before the award year.

• Accelerate or decelerate income, if possible, prior to reporting FAFSA or after the last FAFSA is filed.

• Maximize retirement contributions, which will remove income and assets from the FAFSA.

The important thing to remember is that the best way to pay for your child's college education is to plan to pay for it — as early as possible. It is also important to remember that as much as you may want to help your child out now, you will be doing them a major disservice later if you do not take care of your own financial needs. A banker or financial advisor can help you find the balance between helping your child and meeting your retirement savings goals.

Carol K. Nelson is Seattle market president at KeyBank.