Parents, save for retirement first

With all the hand-wringing over runaway college costs and recent graduates' struggles under the weight of student loans, it's no wonder some new parents start to worry about paying for college before their babies can even walk.

But sometimes, the best intentions don't bring the best solution. Research shows many parents make the mistake of saving for college while ignoring retirement saving. And many parents invest college savings so poorly, they undermine the meager sums they stash away.

In one of the latest national studies on parent priorities, 52 percent of parents told researchers it's more important to save for their children's college educations than for retirement. About one-quarter of the parents surveyed by MarketTools Inc. on behalf of T. Rowe Price said paying for college kept them awake at night.

In the best of all worlds, parents would save for college and retirement. But if cash is short, retirement needs to be the priority, because small savings when parents are young will do more for their future than trying to catch up later.

For example, a 20-year-old who stashes about $20 a week into a stock-market index mutual fund in a retirement savings plan like a 401(k) or an individual retirement account is likely to end up with about $1 million by retirement. But a person who waits until age 45 would have to save about $245 a week to accumulate the same amount. That's nearly $12,750 a year.

If you're saying to yourself, "Who needs a million?" consider that inflation over a lifetime means that $1 million will buy much less than it does today. In about 30 years, $1 million will seem more like today's $400,000.

Perhaps $400,000 sounds like a lot. But given that you might live 25 or 30 years after retirement, that sum will provide only about $16,000 a year for living expenses.

So starting to save on a first job is crucial, even though teens and people in their early 20s recently told researchers for TD Ameritrade they are inclined to put off saving for retirement until paying off college loans, buying a car, and buying a house. That's a prescription for disaster.

Before committing to cars and homes, young families should consider retirement savings a necessary expense. If house payments won't allow you to save for retirement, expectations need to be ratcheted back. As a rule of thumb, it's wise to save 10 percent of pay for retirement every year.

That might leave little available to save for college, but a student can get loans to help pay for college. And a parent who has saved adequately for retirement can temporarily use more of his or her paycheck in a child's college years to cover costs.

Because college savings might be limited, getting the most out of them is crucial. Yet 44 percent of parents in the T. Rowe Price survey said the "best way" to save for college is in a savings account.

You'd be hard-pressed now to find a savings account paying even 1 percent interest. If parents of a newborn committed $100 a month to such an account, they might accumulate $22,000 by college - far short of the $162,000 that four years at a public university is likely to cost.

For a newborn, a balanced mutual fund would make more sense because it combines stocks and bonds - perhaps growing 7 percent a year on average and producing $39,000 by college. But any fund that combines stocks with bonds can suffer losses. Instead, pick a state-offered 529 college savings plan. Anything you save in it is tax-free if the money goes toward college.