Parents Are Jeopardizing Retirement by Taking on Child’s Student Loans

NEW YORK (MainStreet) — Many parents are hurting their retirement portfolios by shouldering the burden for their children’s student loan debt.

A recent survey of 5,000 parents and students by Citizens Financial Group showed that 54% of parents believe their own retirement could be at risk because they are adding additional debt.

While there seems to be a natural inclination that parents want to be able to help their kids pursue their education, it is important for parents to prevent it from impacting their ability to retire, said Brendan Coughlin, head of education and auto finance of Citizens Financial Group, the Providence, R.I. bank.

Of course, the challenges are looming for Boomers and Gen X-ers looking ahead to retirement but tied down to student loan commitments for their kids. The survey found that 45% of parents don’t have a plan to pay for their college child’s student loan debt.

“Whether borrowers manage their debt through private student loans and refinancing opportunities with banks or through federal loans or other means depends on their individual financial situation, [but] it’s safe to say that the vast majority of families looking at the cost of college today find it to be very challenging,” he said.

While parents and children can both take out loans for college, the same option is not available for retirement. To avoid impacting long-term savings or retirement, parents need to set a strict budget on how much they can contribute each semester.

Parents also need to talk to their children about what costs they will be responsible for such as commuting costs, room and board, buying text books or financing their meal plans.

“Help them set a budget and check-in with them at least once a month to make sure they are staying on track,” he said. “This will teach them to be fiscally responsible and understand that Mom and Dad can’t finance their every whim.”

Before taking out a loan on behalf of your child, parents need to discuss alternative options to financing higher education such as having a child live at home, commuting to school or encouraging the child to take on a part-time job on campus.

See into the Future — Month By Month

Determining the amount of the loans each month after graduation is critical for both parents and their children, said Coughlin.

After graduation, there are also many repayment options available to student loan holders, education refinance loans.

Of course, some people will sacrifice accumulating retirement savings and instead aim those funds towards their children’s college costs. Even worse, they will take a loan out against their 401(k) or a withdrawal from an IRA account, said Brent Lindell, a financial advisor from Savant Capital Management in Madison, Wis.

“Think about those possible penalties and taxes on that,” he said. “Is this a wise idea? Absolutely not.”

Many parents make the mistake of thinking they are getting a break from the government when they pay for college out of their IRA funds, said Jack Schacht, founder of My College Planning Team, a Wheaton, Ill.-based college consultancy firm.

Although the government waives the 10% penalty for funds withdrawn that are used for college, parents forget that they are adding to their income when they withdraw funds from an IRA and parent income is typically assessed at 47%, making it a “very bad move,” he said.

More parents are increasing their expectations that their children help foot the college bill. In fact, parents expect children to make an average contribution of 35% toward total college costs, funded through savings, income from working part time jobs and student loans, according to a recent Fidelity Investments survey.

“There is recognition from the parents to have their kids put some skin in the game and make sure the kids get their own value out of their own investment,” said Keith Bernhardt, vice president of college planning at Fidelity Investments, the Boston-based financial institution.

Families said they are on track to meet only 28% their college savings goals and need to find solutions to make up the gap without incurring more debt.

“We heard loud and clear from people that paying for college is a top priority after their retirement,” Bernhardt said. “We know it is hard to do.”

While 85% of parents agree their children should help contribute to college expenses, only 57% of parents with kids ages 13 and older have talked about funding their education, the survey showed. Despite these great expectations, only 34% of parents have asked their kids to start setting aside their own savings.

“Parents should not sacrifice their retirement plans,” he said. “Retirement is critical. You can’t borrow for retirement.”

While many parents have competing priorities and want to make an investment in their children, those who are behind in saving should not sacrifice retirement for college. There are many options when it comes to college, Bernhardt said.

While most parents will gravitate toward paying for higher education, “offering a blank check for college and grad school expenses while skimping on your own retirement can have dire consequences,” said Scott Puritz, managing director of national retirement advisory firm Rebalance in Palo Alto.

Many parents think that raiding their own retirement accounts to help fund college expenses is the “loving thing to do, but it’s also pretty self-destructive,” he said.

“The government subsidizes retirement savings by offering tax benefits and you have one window per year to take advantage,” Puritz said. “There is nothing comparable for college savings.”

Given the “abysmal” state of retirement savings in the U.S., individuals need to save more for retirement, not less and taking on debt to fund a child’s education is “imprudent” for many people, said Robert Johnson, professor of finance at Creighton University’s Heider College of Business in Omaha.

“There simply aren’t many investments that people can make that have a better and more consistent return on investment than investing in education,” he said. “Studies consistently show that earning power increases with a college education and that in terms of lifetime earnings the advantage of a college degree over a high school diploma are in the seven figure range.”