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Next Avenue

Sept. 24, 2022, 3:40 p.m. EDT

Your 401(k) isn’t a college fund. Here’s a guide to paying for your kid’s education without sacrificing retirement.

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By Jennifer Nelson

This article is reprinted by permission from  .

Mya Payton, 58, of Southeastern Pennsylvania, is divorced with four children, the last of whom is in college now. “Over the course of the time my kids were in college — 2014 to now — their dad has been willing to pay for 50% of their college tuition and some related expenses, leaving each kid and me to fund/find the rest.”

Payton has paid her share through a combination of liquidating most of her non-retirement savings, taking out equity in her home, and forgoing all but the bare minimum to her self-employed pension plan (and in at least one year, not making any contribution at all).

To help her last child, Payton said she is considering liquidating some retirement savings next year, when she turns 59½ and thus will no longer have to pay a 10% early-withdrawal penalty included in tax-deferred retirement-savings programs. Her goal, she said, is to “hopefully avoid [student] loans.”

Is that a great idea or one of the worst financial mistakes a parent can make?

Eric Nero, a Certified Financial Planner and president of First-Step Wealth, a comprehensive wealth-planning service in Saratoga Springs, New York, says many parents think that tapping or stopping their retirement savings is a viable way to help their children pay for college and graduate school student loan-free.

A big mistake, made by many

In fact, he says, the resulting loss of compound interest, tax breaks, time, and financial aid eligibility make this one of the biggest financial mistakes parents make.

2022 Retirement Confidence Survey  by the Employee Benefit Research Institute found that more than 4 in 10 working parents say they are reducing what they save for retirement because they are also saving for a child’s college education.

And a recent  report from Morningstar /zigman2/quotes/209325896/composite MORN -1.21% , the financial research firm, says parents who put money in a college fund rather than a retirement account miss out on many thousands of dollars in investment gains, compound asset growth and income tax breaks that can make for a comfortable retirement.

“The vast majority of the time, it is a very bad idea to take savings away from a retirement plan to contribute somewhere else,” says Doug Carey, CFA, owner of WealthTrace, a retirement and financial planning software company in Boulder, Colorado.

That is because contributions to retirement plans such as a 401(k) or traditional IRA are exempt from both federal and state income taxes. Instead, you pay taxes when you take money out of these accounts and presumably you are in a much lower tax bracket.

What’s more, Carey explains that a 529 plan is only pre-tax for state income taxes. If a couple’s marginal federal income tax rate is 32% and they contribute $20,000 to a 529 plan rather than a 401(k), they miss out on $6,400 in federal income-tax savings.

“Not only that,” he says, “but the lost $6,400 does not get to compound over time due to not being invested.”

Reasons to put retirement first

Following are other reasons financial advisers discourage parents from contributing to their kids’ college funds at the expense of their own retirement:

You can’t recoup lost time or taxes.  As you age , you won’t necessarily be able to work at the same high-paying job you did during your peak earning years so putting off saving for retirement until your children graduate could bite you financially.

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