Parents Scale Back on Retirement and College Savings

It's a question many parents struggle to answer: Should savings—if there are any—go toward retirement or the kids' college expenses?

The economic slowdown is making that choice even harder, as many parents are forced to scale back on both financial goals. According to a new study from TD Ameritrade, 36 percent of parents have cut back or stopped saving altogether for their children's education because of the current financial climate. That's despite the fact that most parents estimate it takes 11 or more years to save enough money to cover children's college costs. Meanwhile, TD Ameritrade also found that 1 in 3 adults lacks a financial plan for retirement.

The biggest mistake people make in their 30s and 40s, says Diane Young, TD Ameritrade's investment director, is underestimating how much they can put away for later. "They're thinking they can't save more than they're already saving. But you can. You don't have to go out to dinner four times a week or spend $5 on coffee," she says. That kind of discretionary spending adds up to a substantial impact on savings goals, she says, especially because people often see their peak earning years end in their 50s, making the previous two decades the ideal time to set aside money.

Many people, she adds, have trouble overcoming the "fear factor" of working out just how much money they need to save to cover their goals. To help overcome that paralysis, TD Ameritrade offers consumers a "WealthRuler" that calculates potential savings shortfalls based on retirement contributions, salaries, large expenses such as college tuition, and retirement age.

A 40-year-old earning $50,000 a year who contributes 20 percent of her salary to a 401(k) and who plans to retire at age 65 and send a child to college, for example, should probably be saving around $1,400 a month, assuming average market returns. And even then, WealthRuler predicts, she'll face a shortfall around age 86. (The program estimates such a person would have about $4,275 a month in retirement expenses.)

While 60 percent of parents in the TD Ameritrade survey said they will use money in savings accounts to fund children's education and almost half will rely on student loans, many have plans to turn to more expensive sources. Some 13 percent will take out home-equity lines of credit, and 10 percent plan to use credit cards.

Despite those pricey alternatives, Young says she's concerned about people who scale back their own retirement savings in order to fund their children's tuitions. After all, students are eligible for scholarships and financial aid, while retirees are not.

When an employer's match on a 401(k) is involved, she says, consumers should be sure not to miss it, because those additions accumulate faster than many people realize—and the power of compounding quickly fades away as people age.

After all, Young says, "[Parents] don't want to do all this for their adult children only for them to become bankrupt taking care of [their parents] in their old age" because the parents have no money left for themselves.