By Dr. Jim Dahle, WCI Founder
In a recent talk, college funding expert and financial planner Ann Garcia suggested a rule of thumb for balancing retirement savings and college savings. Her rule had two parts:
- If you're not saving anything for retirement, don't save anything for college.
- If you're not maxing out your retirement accounts, only 10% of your savings should go toward college.
When I first heard this rule, I thought, “That's clever, I should do a post on that.” However, after thinking about it for a week or two, I don't think it's a very useful rule.
Retirement Savings Is More Important Than College Savings
One thing I love about the rule is that it emphasizes the importance of saving for retirement over saving for college. Too many people—probably because college usually hits before retirement and because people “would do anything to help their kids succeed”—put money that should be going toward their own retirement toward their childrens' college savings instead. That's a huge mistake for several reasons.
First, your kid can get a loan for college, but you can't get a loan for retirement. Even better, you and your kid can simply elect to spend less on college. I mean, college pretty much costs what you are willing to pay. Your child WILL get a college education. Maybe it won't be at the “dream school,” but they'll certainly have the chance to go somewhere. Most of the time, it really won't matter all that much where they go.
Second, you need a whole lot more money to retire than to pay for college. Perhaps you need $100,000 for college. But you may need 20 or 30 times that to retire. That means you'll need to save a lot more money for a lot more time to reach that goal. You need to get started early, stay on task, and save a large amount of money every year for your entire career. While the exact amount depends on your individual goals, a good rule of thumb for physicians, dentists, and other high-income professionals with a relatively late start to their careers is to save 20% of gross income for retirement. You don't need to save anywhere near that much for college.
Let's say you want to save up $100,000 in today's dollars over 10 years for college. How much do you need to put away?
=PMT(5%,10,0,100000) = $7,950 per year
For a physician earning $300,000, that's less than 3% of gross income. Even if you have three kids, that's still less than half of what you need to save for retirement.
Third, you can best help others from a position of strength. Let's say your kid gets into their dream school and you want to help them pay for it but you didn't save a thing for college. What other options do you have? The best one is to simply cash flow part or all of the cost of college. You're a doctor, remember? You make $200,000 a year or more. Your household might even make more than $400,000. Surely some of that income can be used to cash flow college costs.
Where will the money come from? You could spend less or work more, but even if you're not willing to do that, you could use some of the money you would have been putting toward retirement and use it to cash flow college costs. Now you're in a position of strength, and you have options. But if you've done the opposite and put all your money toward college thinking that your kid will go to Yale and then they don't go to school at all, now you're stuck paying taxes and penalties on 529 withdrawals to pay for your retirement. That's much worse.
Fourth, lots of retirement savings can be repurposed for college. A taxable investing account can be used for anything you want. Roth IRA principal can be withdrawn at any time tax- and penalty-free. All Roth and tax-deferred IRA and 401(k) money can be withdrawn for qualified higher education expenses at any time penalty-free (and tax-free in the case of Roth accounts). In essence, a Roth retirement account IS a poor man's 529. The only people who should use a 529 are those who have already maxed out their retirement accounts.
More information here:
4 Pillars for High-Income Families Paying for College
How Much Should You Sacrifice to Pay for Your Child’s Medical School Education?
How Much You Should Save for College
So, if that rule of thumb is not useful, what should you do? The purist's answer is to calculate how much you need to save for retirement, save that, then calculate how much you need to save for college, and save that. This requires the use of a financial calculator or spreadsheet, and it's something we teach in our Fire Your Financial Advisor online course. It's really just the “Payment” function on a spreadsheet. Let's say you want to spend $100,000 a year in today's dollars, so you use the 4% rule to calculate that you need a nest egg of $2.5 million. You plan to work for 22 years to get to that $2.5 million. We'll use a rate of return of 5% to reflect a “real” (after-inflation) return. The function looks like this:
=PMT(5%,22,0,2500000) = $64,926 per year
If you can't save that much, well, everything you can save should go toward retirement. If you can save that much, great! If you can save more than that, the additional savings can go toward college. But how do you know when you are saving enough for college? First, you need to estimate, calculate, or simply specify how much you are going to provide for college. For simplicity's sake, this is often just a lump sum to have when your kid graduates from high school. Let's say that amount is $150,000. If the kid is 6 years old, that leaves you 12 years. Again, we can use the 5% real rate of return.
=PMT(5%,12,0,150000) = $9,424
If you already have something saved for college, you simply replace the 0 in the equation above with the amount you have (as a negative number). If you already have $50,000 saved, it looks like this:
=PMT(5%,12,-50000,150000) = $3,783
Why use a rule of thumb (that will often be wrong) when doing an actual calculation is so easy?
But what if your assumptions change? Fine, change the calculation and how much you save then. Like everything else in life, you adjust as you go.
Looking for some personalized answers when it comes to tracking your retirement? Check out Boldin, a WCI partner that helps you build your retirement plan and keeps you on track for the future you deserve. It’s much more than a retirement calculator; it’ll help you get to the retirement of your dreams.
What do you think? How do you balance saving for retirement and for college? How much did you put toward each last year?
As a university professor and a parent, I’ve noticed an interesting pattern: how much parents save or plan to contribute toward their children’s college education often mirrors how much their own parents contributed for them.
In my case, my parents saved $0 toward my education. I was on my own to pay for 12 years of schooling, bachelor’s, master’s, and Ph.D. My wife had a similar experience, covering the cost of all three of her degrees independently. Because of that, we developed strong financial habits early, and now we’re in a position where we can help our two boys with their college costs. But we don’t plan to cover 100% of the cost and that’s intentional.
Contrast that with parents I’ve met whose own college was fully funded by their families. They often feel a strong desire or even obligation to provide the same level of support to their kids. And you know what? I think both decisions are right. They’re simply shaped by different life experiences.
I’ve talked with many parents—some wealthy, some not—and across the board, their college savings plans often reflect not just their income, but also the psychological imprint of how they themselves got through school.
As a professor, I have an added perspective: my children will have access to tuition, free education if they attend certain partner universities through our tuition exchange agreements. That means their biggest expenses will likely be room, board, fees, and books, not tuition. So technically, I’m helping significantly with college, even though it may not show up as a check written directly to the bursar’s office. My wife and I still plan to help with the rest of the costs, but we want our boys to have skin in the game, just as we did.
In the end, there’s no one right answer. What matters most is that parents are intentional, not reactive, about how they support their kids’ education, and that those decisions are made with wisdom, not guilt or pressure.
I agree it should be individualized. As a counter point, my parents helped very little with my education but my kids all have overfunded 529s for their current educational plans. Unless one of them decides to become a doctor, I don’t see how any of them are going to blow through their entire 529s. I’m a lot wealthier than my parents were 30 years ago though.
Thank you for more great insights! Your website and columns are spot-on and so helpful!
Question: So I’m staring at the entries like this: =PMT(5%,10,0,100000) = $7,950 per year
I assume there’s a financial calculator with those fields, but I don’t see a hotlink or any specific reference to one.
Do I assume correctly?
Thanks!
Dave
So that is a payment function from a spreadsheet like Excel or Google sheets. Just copy and paste it in. More info here:
https://www.whitecoatinvestor.com/compound-interest-the-excel-future-value-fv-function/
Related functions are future value (FV), present value (PV), period (NPER), and rate (RATE).It would be a good idea to learn how to use them all. In the payment (PMT) function, the firs variable is interest rate, the second is period, the third is present value and the fourth is future value.
Like some here, my parents did not save anything for any of my college costs. But, they also weren’t maximizing their retirement accounts. My father ended up on social security subsistence from age 62-79…with a benefit of $700-$800 a month…total. He drove a $600 beater car as his last vehicle. He read the neighbor’s used newspaper and stood in line for free government cheese…actual blocks of processed cheese. He told me: “Don’t end up like me…”, so I listened.
I was saving for my kid’s college since 1995. Initially with a UGTMA account and later, four 529 accounts. I used to put away about $10,000 a year…not enough. These accounts are winding down at this point and are worth half what they were at their height. I have always had to supplement them from my side gig earnings as we did not save enough despite the last three children going to an inexpensive state school. The cost of a four year degree for each with room and board has averaged about $70K to $80K each for the first three.
As you say, one can make up for the error of not saving enough for college from earnings…and more years of work.
I borrowed almost all of my college and room and board costs. It took about five years of “living like a resident” and a total of 7-8 years to pay them off.
Our biggest gift to our children besides loving them and being their number one cheerleader forever will be a graduate degree for each with no debt. Generally, I maxed out our retirement funds first, but sometimes we made up for any errors in planning with extra work.
That’s a pretty sad story about your dad Anthony.
I’m not sure I understand why $10,000 a year was not enough for your kids college if they went to inexpensive state schools either. When I run the numbers (18 years, $10K a year, 5% real returns) I get a total of
=FV(5%,18,-10000,0) = $218,000 Plus growth that happens during school, which might be another $30K.
How is that not enough for 4 years at an inexpensive state school? What am I missing? Did you save $10K total not $10K per kid? Did you not start until they were older?
Right…it was $10,000 per year total, not per child. So, the first one had a UGTMA account that had about $20K in it. She got a scholarship for the first two years and lived at home. The last two years were at a private school…so $30K a year despite work study and a transfer student scholarship.
The last three had the $10K a year split between them for about eight years and this $80K put in was worth about $150K eventually. This has paid for the second and third with some supplemental from my side gig, but we decided to pay room and board for them in grad school from our cash flow.
There is about $60K left for our youngest. He has a small renewable scholarship that will help.
After putting $90K a year into retirement funds, we did not have enough left to put away $10K per child. Sort of proved your point though…that saving for retirement over college is better.
That makes sense.
Interesting post and comments. When our children were preschoolers, we began putting about $100/month for each child in 529s. As they became tweens, I realized they were unlikely to qualify for need-based aid, so I dumped lots of money in for several years. Putting in these extra funds wasn’t easy because 1) we were using our discretionary spending and 2) we were making the contributions during and immediately after the Great Recession. We achieved our goal of saving enough to pay for 4 years at a state school. We were maxing our retirement accounts by this time. We just didn’t have much left over for fun stuff; it was all going to retirement and college. Then each child lucked out and received a full merit scholarship, so the 529s sit largely unused. We’ve told our adult children that we won’t reabsorb the funds and that they can use them for graduate school, but so far, no takers.
How much we saved was definitely influenced by our own experiences. My dad was the first and only one in his family to attend college, and he did it by working in the college cafeteria and spending summers helping with harvests in the midwest. When his father died and the small farm was sold, my mother told me he took his portion of the inheritance and used it to seed the college accounts of his then three children. He and my mother continued to save for college, forgoing the purchase of a bigger house. But my brothers and I were on our own for our masters degrees.
Not sure it’s “lucking out” to get merit scholarships. That usually represents significant work during high school in academics, the arts, or athletics. Or at least a wise decision about what school to go to.
Good post. Number of children matters. With fewer children you can apply more resources per child than if more total children.
They are just different strategies. If you have many children you are more likely to have a few that have the internal drive and can “pull themselves up by the bootstraps” regardless of the circumstances. Whereas fewer kids you can more intensely apply resources and more likely set up each individual for more success. Both strategies have pros and cons.
I agree with the general advice. As any personal finance it is personal as well. I became a father relatively late ( late 40’s) and we are in our peak earning years. There is no way my kids will qualify for any financial aid. I opened 2 different 529 accounts for each kid when they were born and both my wife and I have been putting the max allowable without incurring gift tax. Our thought is we don’t know how our income is in few years and want to front load the accounts while we are earning well. It is hard to cash flow their college because I will most likely retire by then (age 65). We are still able to save about 30% of our gross for retirement so hopefully will work out.
Yes, it’s going to work out just fine if you save $19K for college every year for a few years and are putting 30% of your money toward retirement. I love White Coat Investors but many of you need to worry a little less. You’re crushing it.
Even more so… Seems like they are saving $38k per child per year (both wife and commenter are hitting the “gift tax free max”
Yes, we are doing 38k per child per year for now. That might be a little overkill but will likely cut down from that in few years.
A couple of things to share on college. First, if you’re fortunate enough to have a WCI income and are debt free, cash flowing college was remarkably easy. Second, younger folks need a way to tactfully raise the issue with grandparents, or maybe it’s the other way around.
I always wonder how these helpful suggestions need to be adjusted for someone with a military pension on the way. I’m still active duty but will eventually start collecting at least $7,000/month (assuming zero disability). So for me it seems maxing out Roth IRA might not be as important as putting money in 529s. Still, the concept of pulling principal from a Roth is something new to me. I’ve only been putting $100/month in each my and my wife’s Roth, while putting $300/month in each daughter’s 529. They both get 1/4 of my GI Bill as well which will help. Thinking I might shift more to our Roths, knowing it could still be used for education.
In line with above comments. I got $0 support for college from parents but I am in a better financial situation than my parents were.
Navy funded my AA, BS, BSN, MSN, and finally DNP degrees and now they’re even helping a bit with my kids college even if they don’t serve (transferred GI Bill). Military can be a sweet deal for education, especially if starting out with nothing.
The more of your retirement that will be provided by the pension, the less you should theoretically have to save for retirement and theoretically should be putting a little more toward education, no? Of course, having the GI bill has the opposite effect.
Love the explanation of cash flowing college!
In addition to income from a job, you could also use income from rental properties. That’s something I’m planning on doing. The added benefit is that I can then use that rental income for retirement later on.
Essentially, the same investment property can be used to accomplish both goals, saving for college and then retirement.
Thanks!
Matt
That is true. Worst case scenario, it could also be sold, capital gains and depreciation recapture taxes paid, and the proceeds used to pay for school. I wrote about using rental properties to pay for college here:
https://www.whitecoatinvestor.com/real-estate-as-a-college-savings-tool/
I agree that how much you are willing/able to help each kid needs to be individualized (both for the kid and for you parents). I tend to be more pessimistic about my kids’ ability to make a great living even with a college degree, and not only because none of them followed us in medicine, but because of AI, trade wars, cost of housing where we live, and so on. I wonder how others on this chat feel about that and if those worries influence their decisions. We are helping both of our boys to finish college debt free and this was not even a discussion. We started 529 the week they were born and that covers their tuition at private colleges, while we cash flow room and board and travel and spending money. They also life guard in the summers.
As always, appreciate this forum and thank you for these great discussions.