Take care of retirement first, then college fund

Doing it that way might even help children get more financial aid

Dollars & Sense

November 02, 2003|By Liz Pulliam Weston | Liz Pulliam Weston,SPECIAL TO THE LOS ANGELES TIMES

I'm an underemployed single mother living in New Jersey. I have the good fortune to have an inheritance coming to me soon - and a gaggle of teen-age daughters either in college or about to start.

We've been living in moderate poverty for the last 10 years, so there is nothing worth mentioning in savings. I had an IRA, but my car ate it. I'm afraid that the inheritance will disappear into my girls' education, leaving me without means for retirement. Or worse, that I'll be able to keep my money, but my children won't qualify for enough financial aid to attend school.

At the very least, I'd like them to go to college and graduate without being hobbled by their student loans. What would you recommend?

First things first. Your desire to provide for your daughters' education is admirable, but nobody is going to lend you cash to retire. And as much as they love you, your daughters don't want to support you in your old age. So make sure you take care of your own retirement before contributing to their college funds.

The good news is that saving for your retirement might wind up helping your daughters get more financial aid. Most financial aid calculations don't include retirement funds or home equity. (The exception is elite private schools, but you can cross that ivy-covered bridge if your daughters come to it.)

Savings accounts and other nonretirement assets are counted, but you're expected to contribute only the equivalent of 5.6 percent of those each year to the cost of school. In contrast, students are expected to contribute 35 percent of assets.

The other thing you should know is that financial aid is based primarily on income. If you don't make much money, the federal financial aid calculation pretty much assumes you won't be able to cough up much for your daughters' schooling. If you make a lot of money, the opposite assumption is made. You're expected to contribute more, whether or not you think you can.

Your first step is to make sure you have an adequate emergency fund - one equal to six months' expenses would be ideal. Next, you need to know how much to save for retirement. Personal finance software such as Quicken or Money can help with these calculations, or you can use one of the many retirement calculators on the Internet.

Once you know how much you need to save, you can start contributing the maximum to any workplace retirement plans available to you, using money from your inheritance to replace any reduction in your paycheck. In addition, contribute as much as you're allowed to an individual retirement account ($3,000 this year, or $3,500 if you're over 50).

Multiply these amounts by the number of years you have left until retirement and keep that money available so that you can continue your contributions in the years ahead. (If you're able to put $3,000 each into a 401(k) and an IRA, for example, and you're 40, you'll want to make sure $150,000 of your inheritance is set aside for this purpose.) You can invest this money to generate higher returns than you'd get in a savings account, but make sure you keep enough cash on hand to make each year's contributions.

If your inheritance exceeds these needs, you can give some thought to college savings. Given your low tax bracket, though, it doesn't make much sense to contribute to any tax-deferred college savings accounts, such as 529 plans or Coverdells, formerly known as education IRAs. You won't get much tax benefit, and these accounts all have restrictions that could prove cumbersome.

You're better off keeping the money in your own name and paying your daughters' college bills directly.

My question is simple, and you've probably addressed it before: Is an individual entitled to a free credit report from all of the big three credit bureaus? If so, how do I go about it?

You're entitled to one free credit report from each bureau annually only if you're a resident of Colorado, Georgia, Maine, Maryland, Massachusetts, New Jersey or Vermont.

You can also get a free report from a credit bureau if you are unemployed, are on welfare, are the victim of fraud or have been denied credit by a lender that used information obtained from that bureau.

The bureaus' Web sites (www.Equifax.com, www.Experian.com, www.TransUnion.com) have information about how to obtain reports, or you can call them: Equifax, 800-685-1111; Experian, 888-397-3742; and Trans Union, 800-888-4213.

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