Retirement vs College Savings - Overcoming the Funding Conundrum

Life is a constant juggling act. Every day we juggle tasks, time, people and goals. This is especially true when it comes to balancing financial goals, whereby time is not the scarce resource, but money is. The future can seem especially daunting for young families balancing retirement funding goals and college planning for their children. When a dollar can only stretch so far, how can you effectively plan for both?

Advanced education is vital, but it comes at a cost. Short of saving for retirement or buying your dream home, no other expense has that great an impact on the family finances. College costs increase at about twice the inflation rate. Current increases have averaged 5% to 8%. In fact, it is estimated that by 2020, a four year college education could be as much as 7,000 at a private institution and 3,000 at a public one, based on College Board estimates. Ouch. But, are you
really prepared to sacrifice your own financial security during retirement for your child's education?

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As expensive as it is to send junior to college, retirement is even costlier. Sadly, nearly half of American households are not saving at all; and two thirds are not saving enough to retire adequately. Couple that challenge with a desire to fund your child's education and you may have a serious economic dilemma on your hands.

Paying for School

College expenses are traditionally paid from one of several sources: parent's current income, financial
aid/scholarships/grants, and parent's personal savings. Over the past several years, however, a proliferation of college savings programs have been introduced including prepaid tuition programs, including:

Coverdell Education Savings Accounts

Formerly called Education IRAs, a Coverdell ESA allows you to put ,000 away each year per child (if eligible), and you can usually invest the money however you like. Distributions are tax-free when used for qualified elementary and secondary education, as well as qualified college education expenses.

Prepaid Tuition Programs

Prepaid tuition plans are college savings plans that are guaranteed to increase in value at the same rate as college tuition. The main benefit of these plans is that they allow a student's parents to lock in tuition at current rates. While the state plans vary, if the student attends an in-state public college, the plan pays the tuition and required fees. If the student decides to attend a private or out-of-state college, the plans typically pay the average of in-state public college tuition.

529 College Savings Plans

These plans are a popular choice because they offer the account owner control and
flexibility, combined with special income tax and estate benefits. Section 529 college savings plans are tax-exempt college savings vehicles with a low impact on need-based financial aid eligibility. Unlike prepaid tuition plans, there is no lock on tuition rates and no guarantee. Investments are subject to market conditions, and the savings may not be sufficient to cover all college costs. However, with this added risk comes to opportunity for potentially earning greater returns.

Today, there are many choices available for parents, but the most important consideration in planning for college or retirement is to start saving as early as possible. The earlier you start to save, the lower the regular contributions will have to be. It's never too late, or too early to start.

Set Priorities

It's not easy to be a disciplined saver, but there is no way to survive this funding conundrum without it. In an age where instant gratification is a way of life, it's tempting to spend today and worry tomorrow. Spend less and save more, while unpopular advice, is necessary advice. The alternative will get you nowhere. So, setting and maintaining a budget will be critical to your success. It's nice to spoil our children, but do they really need fifty-seven Xbox games in their collection? Is that trip to Disney really necessary every year? Sacrifice today will help assure a better future tomorrow.

Get the Kids Involved

Parents should be straightforward with their children about how much they will be able to afford. If the child wants to go to a "name-brand" school that costs ,000 a year, but the parents can only afford ,000 a year, the student can take part in the choice to find alternative financing or go to the more cost effective school. Remind them that if mommy and daddy don't have enough money in retirement, because they spent all their money on college funding, they should get used to the idea of having them as roommates to support when they're all grown up. So, run the numbers together to see which universities your family can afford. Compare the costs of attending public vs. private institutions and consider the possibilities for financial aid.

The federal government has made it possible for virtually anyone to attend college, despite cost and despite parent's income. Student loans and parent loans are readily available at low interest rates and payments are often deferred until the student graduates (for most full time students). Too many families incorrectly assume that they won't qualify because they feel they are too wealthy, but this is not the case. The application process may be somewhat cumbersome, but the benefits far outweigh the (time) costs.

The best financial aid, of course, is free money. Much of the student financial aid comes in the form of loans, but there are grants and scholarships readily available for that patient enough to search for them, and qualify for them. Check out The College Board for more information about college costs, scholarship search strategies and financial aid.

Working While Studying

Parents who wish to only partially subsidize education for their kids (or not fund it at all) have a number of alternatives. Students can apply for loans, work-study or (gasp) get a job. Asking a college student to work and/or take out loans may not seem attractive now (especially for the student). But, there is something to be said about a child that works his way through school. They're often hungrier, eager and motivated to succeed. Those traits can take you far in life. In fact, some of the best and brightest professionals have managed to do well in school while also managing a job, present
company included. After all, the kids can get student loans to fund education, but when is the last time you heard of retirees taking loans to fund their retirement?

Consider a Whole-Portfolio Approach to Investing

Don't want to bother compartmentalizing your "pots of money"? No problem. Many of my clients have opted for a more holistic planning approach. A whole-portfolio approach takes into account all of your taxable and tax favored investment accounts. With this approach, you can always earmark certain buckets of your portfolio for certain things. But putting it all together in one portfolio provides a big-picture view of your overall asset allocation. That way you can manage your total portfolio risk at any given time.

This approach allows you to incorporate your various goals, including college and retirement, into the big picture as you plan for future spending needs. You may find that the financial pie is actually big enough for both, or you may need to adjust one goal or another.

Closing

So, which one is it-college or retirement? Ideally, you don't want to sacrifice one goal for the other. Try to balance the two so you don't shortchange your future or your children's in the process. The decision to put your child's education before your own retirement is not only an economic decision, but also, an emotional one. Parents feel a sense of
obligation to provide a better way of life for their kids, but if they plan carefully, they won't have to risk their own well being
in order to accomplish this.

The consequences of funding education before funding retirement may lead to inadequate retirement funds or
prolonging your work years. The choice is yours, so choose wisely.

Retirement vs College Savings - Overcoming the Funding Conundrum

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How Bankruptcy Will Shield Your Retirement Investments

If you are facing financial straits and have a nest egg of a retirement to consider, bankruptcy can be filed to shield IRA assets from creditors. Qualified retirement plans such as employer-sponsored plans like 401(k)s and 403(b)s are afforded protection under ERISA; therefore, they are not part of the bankruptcy estate and are also protected from other types of judgments.

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The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, commonly referred to as BAPCA, extended these same type of ERISA protections to IRA's and certain other investment products in a bankruptcy proceeding.

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So what does this mean for the investor? IRA investors now are even shielded further against creditors than they were before BAPCA. It is common in today's job market for the average worker to change jobs numerous times during a career, resulting in many 'orphan' IRAs that the investor thereby ends up consolidating into a single IRA. So, fear not your portable nature and the investment behavior that led to an IRA consolidation. BAPCA is here to save the day.

The following are the protections that a bankruptcy filer will be afforded in regards to their IRA investments:

Section 522 of the Bankruptcy Code states, in relevant part:
(n) For assets in individual retirement accounts described in section 408 or 408A of the Internal Revenue Code of 1986, other than a simplified employee pension under section 408(k) of such Code or a simple retirement account under section 408(p) of such Code, the aggregate value of such assets exempted under this section, without regard to amounts attributable to rollover contributions under section 402(c), 402(e)(6), 403(a)(4), 403(a)(5), and 403(b)(8) of the Internal Revenue Code of 1986, and earnings thereon, shall not exceed ,000,000 in a case filed by a debtor who is an individual, except that such amount may be increased if the interests of justice so require.

In layman's terms this adds up to the following protections for IRA investments:

o Note that I will mention that certain property is either excluded from the bankruptcy estate altogether, or exempt under federal and/or state law. In either case (exclusion or exemption), the asset remains protected from creditors.
o How much will the bankruptcy umbrella protect and what is protected? All retirement funds exempt from taxation under Sections 401, 403, 408, 408A, 414, 457 and 501 of the federal tax code are now protected from the reach of creditors. Contributory and Roth IRA assets are capped at an amount of million (inflation adjusted). Therefore, there is million cap on the IRA investment amounts. Because of IRA's fairly recent inception (1974) and a ,000 cap on contribution that was in place until 2002, its safe to say that the million cap should provide a big enough umbrella for today's IRA investors.
o Now read in Section 522 the language stating, "without regard to amounts attributable to rollover contributions." This means that rollover IRA's are exempted in bankruptcy, thus allowing qualified retirement plan assets that are rolled over to an IRA to exceed the million limit that's in place for contributory or Roth IRA assets. Therefore, 'roll over strategy' should be discussed with your attorney to provide maximum protection in bankruptcy. Now read the language stating, "except that such amount may be increased if the interests of justice so require." This is once again referring to the million dollar cap. This leaves the court with a lot of wiggle room and may not be a reliable legal crutch. I would advise seeking counsel in the bankruptcy vicinage which you will be filing, to see what of protection can be expected in that district.
o Whereby ERISA failed to protect the independent IRA investor, BAPCA saves the day. BAPCA provides welcome protection for sole proprietors who typically invest in Keogh and/or 401(k) plans.
o BAPCA was also written to include Simplified Employee Plan (SEP) and Savings Incentive Match Plan for Employees (SIMPLE) IRA's. These IRA investments are excluded and are protected for unlimited amounts.
o Money that you have put away for your children's education in protected under BAPCA. Coverdell Education Savings Accounts (ESA) and state-sponsored Section 529 college savings programs are included. Any contributions made to these products for a child, grandchild, stepchild, or step-grandchild more than two years before the filing are protected. Those monies contributed more than 365 days but less than 720 days before the bankruptcy filing are protected only up to ,000 per beneficiary.

How Bankruptcy Will Shield Your Retirement Investments

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Preparing Income Taxes - When You Withdraw Retirement Funds "Before Their Time"

There are a variety of qualified savings/retirement fund plans available to taxpayers. Some like traditional and Roth Individual Retirement Arrangements (IRAs) are specifically designed for a taxpayer's retirement years. Others, like a health (or medical) savings accounts (HSA/MSA) and (Coverdell) Education Savings Accounts (ESA) are established for specialized needs such as medical or educational expenses respectively. According to the Internal Revenue Service (IRS), you can contribute or add money to these funds oftentimes on a tax-deferred basis. These qualified contributions typically have some incentivized tax treatment; they either reduce taxable income (like an IRA) or provide a tax credit (like a Saver's Tax Credit). However, there are strict rules regarding the withdrawal or distribution of these same funds. You might receive preferential tax treatment if you make a contributions to these funds but be warned; you could be taxed most likely at your marginally income tax rate AND suffer "early withdrawal" penalties if you drawn down these funds "before their time" or for any reasons other than for those for which they were originally intended.

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IRS Form 5329, Additional Taxes on Qualified Plans (including IRAs) and Other Tax-Favored Accounts is an eight-part tax form that calculates additional taxes on early distribution, distributions from ESAs, IRAs, and HSAs. It also reports additional taxes on excess accumulations in qualified retirement plans when contributions exceeded IRS rules. If you receive, for example, a IRS Form 1099-R and Box 7 shows a code 1 (early distribution without exception) or code 2 (early distribution with exceptions), you might be subject to an additional 10% tax penalty in addition to the income taxes levied on the additional income resulting from the distribution. A Form 1099-INT also reports an early withdrawal penalty amount. For example, if you receive a Form 1099-R with code 1 in Box 7, there are no exceptions to the early withdrawal penalty and you will be charged a 10% penalty that will be computed in Part I of IRS Form 5329. You also file Form 5329 to report regular, or rollover conversions from one type of qualified retirement fund to another.

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Tax and financial implications of what might appear to be simple transfers of "your money" can be VERY complicated especially if they violate IRS rulings and regulations. Consult a practiced tax professional if possible BEFORE you take any financial action. There are ways to avoid penalty fees under qualifying circumstances. If you have received distributions from any of these plans and an IRS Form 1099-R, have a tax professional review your tax returns.

Preparing Income Taxes - When You Withdraw Retirement Funds "Before Their Time"

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