balancing actsderail investment plans. burdened by their own student loan debt, many are determined...

Balancing ActsInvesting for college without sacrifi cing retirement

I N B R I E F• Investors should save 15% of income throughout their working years to secure a

comfortable retirement, given the likelihood for entitlement reform, tax increases and lower market returns.

• Saving 15% for retirement alone is a tall order. Can families also meet rising college costs without saving even more? We found it’s possible but only if they start early, contribute regularly and invest tax efficiently.

• Proper balance is needed when college and retirement portfolios are funded from the same 15% savings pool. Emphasizing one goal at the expense of the other can ultimately jeopardize both.

• Factoring in a home purchase or private college will likely require higher savings rates, financial compromises or gifts from family members.

A U T H O R S

S. Katherine Roy, CFP®Chief Retirement Strategist,J.P. Morgan Asset Management

Michael Conrath, CFP®, CRPC®529 Program Director,J.P. Morgan Asset Management

2 BALANCING ACTS: INVESTING FOR COLLEGE WITHOUT SACRIFICING RETIREMENT

ONE OF THE KEYS TO SUCCESSFUL INVESTING IS BALANCE , whether it’s finding the optimal trade-off between risk and return or diversifying across a mix of stocks, bonds and other asset classes.

Balance is also paramount when it comes to life’s two most important financial goals. The question facing families isn’t whether to invest for college or retirement. It’s how to effectively invest for both — often at the same time, from the same pool of investible assets.

This paper examines the balancing acts investors must perform between college and retirement, between their desire to spend and need to save, between challenges outside their control and solutions within it.

BALANCING ACT: FINDING THE MIDDLE GROUND BETWEEN COLLEGE AND RETIREMENT

Most investors understand why they need to plan for college and retirement, but they struggle with the how. How should they prioritize the two goals? How much money will it take to achieve each? How should they divide their savings?

In their early years before having children, some people may invest for retirement by default if they are automatically enrolled in a 401(k) plan. In general, though, 20-somethings don’t recognize how important an investment made today could be in their 70s or 80s. If they save at all, it’s likely for shorter-term needs like the purchase of a home.

While retirement isn’t a top priority for younger investors, it certainly should be. Unlike college, which can always be financed with loans, retirement must be pre-funded. Almost all the money retirees will ever need must be accumulated before they end a career. While there may be some Social Security or pension benefits to supplement income, there are no loans, grants or scholarships for retirement. There are also no paychecks to help defray or delay some of the expenses. In fact, health problems, employer issues and family obligations often prevent people from working as long as they had planned.

The difficult decisions between retirement and college usually arise after children are born. This is a time when parents may allow college savings to diminish retirement contributions and derail investment plans. Burdened by their own student loan

debt, many are determined to see their children avoid the same fate, even if it means sacrificing their financial security. What they may not realize is the devastating effect that years of lost compounding can have on retirement, as fewer dollars are given less time to work.

A better approach is to strike a balance between goals, because emphasizing one over the other can ultimately jeopardize both. Parents who don’t accumulate enough for college may have no other choice than to tap into retirement accounts or take on crushing debt that limits the ability to save. Those who can’t afford retirement run the risk of becoming the very financial burden they wanted their kids to avoid.

BALANCING ACT: INCREASING RETIREMENT SAVINGS FROM 10% TO 15%

Conventional wisdom has long held that investors need to set aside 10% of their gross income each year to fully fund retirement. At J.P. Morgan, we now suggest higher-earning families increase that savings rate to at least 15%, excluding any company matches in an employer-sponsored plan.

Why the change? Looking ahead, we believe current and future retirement investors will face stiffer headwinds than past generations. Taxes are likely to be higher. Stock and bond market returns may be lower than recent decades. Social Security could replace smaller percentages of workers’ paychecks. Health care expenses might rise faster than Medicare’s ability to pay for them. Put it all together and you get longer, costlier retirements, funded with more personal savings and fewer investment gains and government entitlements.

College investors can expect to encounter some of the same challenges, along with a few unique to the higher education landscape:

• Tuition costs are rising faster than household income, requiring families to now pay at least some of the bills from their portfolio instead of their paycheck (Exhibit 1).

• Student loan debt is soaring, putting a financial strain on families that could last for generations (Exhibit 2).

J .P. MORGAN ASSET MANAGEMENT 3

• Federal financial aid has actually declined by $23.4 billion since 2010-11.1 At the same time, applications continue to rise, leaving fewer dollars to go around.

EXHIBIT 1: COLLEGE COSTS AS A GROWING PERCENTAGE OF MEDIAN FAMILY INCOME2

BALANCING ACT: FOCUSING ON BEHAVIORS AN INVESTOR CAN CONTROL

Many of the roadblocks to retirement and college are largely outside a family’s control. The good news is that they have complete control over the savings and investments needed to overcome such obstacles.

So what will it take to achieve a carefree retirement and debt-free college education? It won’t be easy. Saving 15% each year is a daunting task, even for more affluent families. Will it be enough to also fund college? What if parents want to simultaneously invest for a new house or incur other major expenses?

While everyone’s circumstances are different, most investors can use these strategies to find an effective balance between college and retirement.

Avoid the “lost savings decade” of the 20s

When savings rates among Millennials rose in the aftermath of the great recession, it was hoped they would become the same thrifty savers as their great-grandparents of the Silent Generation. Unfortunately, as our economy recovered, the urge to consume proved stronger than the need to conserve. Today, the savings rate among younger Americans stands at an alarming negative 2%.4

Reasons for not saving can be both financial and emotional. Millennials struggling to find good jobs and pay off student loans simply may not have the money to save (Exhibit 2). Those at the higher end of the income spectrum must overcome the natural human tendency to procrastinate, especially when it comes to a retirement still 40 or more years away.

Think of the missed opportunities. Investments made in the 20s can have the biggest impact on outcomes because they have the longest time to grow. Procrastinators will never get back that precious decade of compounding and may have to either save more than 15% in later years or risk falling short of financial goals.

Baby Boomersin college

Generation Xin college

Millennialsin college

20% 24% 32%

EXHIBIT 2: THE VICIOUS CIRCLE OF STUDENT DEBT AND THE “LOST SAVINGS DECADE” OF THE 20s

Parents who don’t save enough for college often raise children who don’t invest enough in their 20s because they’re overburdened with debt. Nearly three of four student borrowers (73%) say that loan payments force them to put off investing for their fi nancial goals.3 Not investing in early years, when it could have made the biggest diff erence, means the next generation will also likely borrow for college…and the cycle begins anew.

PARENTSSave too little; must borrow for college

CHILDRENToo much debt toinvest in their 20s

GRANDCHILDRENAlso must borrow heavily to fund college

>

>

>

1 Source: The College Board, Trends in Student Aid 2014. Based on undergraduate student aid in 2013 dollars. For illustrative purposes only.

2 Source: U.S. Census, 2012. Parents of Baby Boom generation are assumed to be the Silent Generation (1925-1945). Parents of Gen X are the Baby Boomers (1946-1964). Parents of Millennials are Gen X (1965-1981). Median income is the average of the entire generational cohort while their children are in college. All values are 2012 dollars. For illustrative purposes only.

3 Source: American Student Assistance, 2013. For illustrative purposes only.

4 Source: Moody’s Analytics, as reported in The Wall Street Journal, November 9, 2014. For illustrative purposes only.


Our recommended 15% savings rate for retirement is based on how people typically behave, not how they should ideally behave, especially when balancing multiple goals. Our models assume that retirement savings begin at age 25, with contributions only large enough to maximize the company match in a 401(k) plan. By 30, when first homes have been bought and emergency reserves funded, investors are able to dedicate more of their savings to retirement. However, to achieve both retirement and college goals, they will have to start saving the full 15% as early as 22.

Assign savings to separate “mental accounts”

The concept of mental accounting can help bring balance, discipline and clarity to investors pursuing both goals. Instead of trying to manage one broad, undefined pool of savings, they can mentally assign some dollars to college and others to retirement. Money earmarked in this way is less likely to be spent or squandered for other purposes, especially if a separate investment vehicle is dedicated to each goal.

The amounts going into each mental account can be adjusted at different stages of life. For example, parents might maximize retirement savings before their children are born and again after college graduation.

Be a college investor, not just a saver

Most people are willing to take at least some risk with their retirement assets, but a child’s college fund tends to be viewed more emotionally and invested too conservatively. In fact, some of the most commonly used college vehicles include savings accounts and CDs now earning interest rates well below the tuition inflation rate (Exhibit 3). When families start planning early, college becomes a long-term goal suitable for longer-term investments with higher return potential.

Hands off retirement accounts

About one in five college savers expects to use retirement funds to pay for school.5 This is almost never a wise decision, as it can negatively affect both parents and children. For parents, retirement withdrawals deplete the account and are generally subject to taxes as well as penalties if made before age 59½. For children, those withdrawals are treated unfavorably as student income for financial aid purposes (Exhibit 4).

Loans from a 401(k) similarly diminish the account’s earning power and must be paid back with interest. While borrowers are repaying loans, they typically lose out on any company matches. If they leave their employer, they may be required to repay the full loan within 60 days to avoid taxes and penalties.

EXHIBIT 4: THE RELATIONSHIP BETWEEN RETIREMENT SAVINGS AND COLLEGE FINANCIAL AID

EXHIBIT 3: HOW U.S. FAMILIES SAVE FOR COLLEGE PERCENT OF FAMILIES USING EACH ACCOUNT5

While in an account, 0% of parents’ retirement assets are considered in federal fi nancial aid formulas. However, withdrawals taken to pay for college are treated as student income, the single biggest factor the government evaluates before awarding grants and other aid. More specifi cally, a full 50% of student income above a protected amount currently counts against federal aid packages.

UGMA/UTMA

Investments

529 plan

Savings accounts

Trust fund

CDs

Retirement accounts

10%

11%

18%

20%

29%

45%

16%

Taxable Low-yielding Tax-advantaged

0%

50%

5 Source: Sallie Mae, How America Saves for College, 2014. For illustrative purposes only.


EXHIBIT 5: WHAT IS A 529 COLLEGE SAVINGS PLAN?

A 529 plan is designed to help families invest for college on a tax-advantaged basis. Taxes are deferred on investment gains, and withdrawals are entirely tax free when used to pay qualifi ed higher education expenses.7

Though generally state-sponsored, 529 plans are available to families across the U.S. and can be used at any accredited college in any state, as well as many colleges overseas.

M E E T T H E L E E F A M I L Y

The Lees are a 28-year-old married couple with one newborn child and a second who will arrive in another two years when the couple turns 30. Their combined salaries currently total $137,000, roughly twice the median household income (Exhibit 6).

EXHIBIT 6: THE LEE FAMILY

FAMILY SITUATION • Both spouses age 28, with a newborn child and another to be born in two years

INCOME • Roughly twice the median, starting at $120,000 at age 22

• Grows 2.25% each year until 65

RETIREMENT SAVINGS • Start at age 22, continue to 65

• Assume 3% company match in 401(k) plans (or 50% of contributions if contributing less than 6%)

• Earn 7% investment returns each year on a tax-deferred basis

COLLEGE SAVINGS • Start at child’s birth, continue to age 18

• Earn 6% investment returns each year

Retirement objective: $4.8 million at a minimum, $6.3 million ideally

Based on what we know today, we estimate the Lees will need at least $4.8 million to have a reasonable level of confidence in replacing the $312,000 salary they are projected to earn at age 65. Bear in mind that we assume their income will rise by only a modest 2.25% inflation rate each year. If pay raises, promotions and career changes were also factored into the equation, the Lees could need an even bigger portfolio to replace a larger paycheck.

Minimize the tax bite

Employer-sponsored retirement plans and, more importantly, their company matches have become absolutely critical to retirement security, yet less than half of Americans are eligible to participate. Even fewer families (29%) are investing on a tax-advantaged basis in 529 college savings plans (Exhibit 5).6 As a result, investment gains that could be going toward lifelong goals are instead eroded by taxes each year.

On the pages that follow, we’ll show you how these strategies apply to a hypothetical married couple with two young children. You’ll see the smart retirement choices they need to make immediately upon entering the workforce and consistently throughout life. You’ll also see how decisions about college and other financial goals have a direct and significant impact on their retirement readiness.

CONTRIBUTIONSTax deductible in some states

529 PLAN INVESTMENT PORTFOLIOSTax-deferred growth potential

WITHDRAWALSTax free for qualifi ed higher education expenses7

6 Source: Sallie Mae, How America Saves for College, 2014. For illustrative purposes only.

7 Earnings on non-qualifi ed withdrawals may be subject to federal income tax and a 10% federal penalty tax, as well as state and local income taxes. For illustrative purposes only.


There are other reasons for the Lees to aim higher than their $4.8 million retirement checkpoint (Exhibit 7). Like any prudent financial planning model, ours reflects what we know to be true today. If circumstances change in the future, so would the Lee’s retirement savings target.

Take taxes as an example. The Lees diligently invest in tax-deferred accounts, which means they will owe taxes on withdrawals taken during retirement — at rates likely to be higher than those currently in effect and reflected in our checkpoint.

Future entitlement reforms and below-trend investment returns could create similar drags on the Lee’s retirement outcome. Given these potential headwinds, we believe they would retire more comfortably and confidently with $6.3 million, which appears achievable with our recommended 15% annual savings rate.

College objective: Fully fund public universities

The Lee’s college goal is equally ambitious. They want their savings to cover 100% of the tuition, fees and room and board for four years of public college per child — without relying on student loans and other funding sources beyond their control.

How much will they need? The average in-state public college costs $18,400 today. If prices rise 5% each year, which is roughly in line with increases over recent decades, the Lees must invest and earn enough to pay:8

• Child 1: $48,000 average cost per year, starting in 2033


BASELINE CASE: WHAT IF THE LEES DO EVERYTHING RIGHT?

Achieving both college and retirement goals will require the Lees to make sound decisions over their entire adult lives. It starts at age 22, when they begin contributing 15% ($18,000) of their combined income to retirement accounts each year. In order to achieve their college goals, they must redirect 3.4% of those savings per child into 529 plans ($4,663 and $4,875 in the year children are born, increasing annually with income). Those contributions continue until college arrives and then are once again allocated toward retirement (Exhibit 8).

EXHIBIT 8: SAVINGS RATES

AGES RETIREMENTCOLLEGE

(529 PLAN) TOTAL

22-27 15% - 15%

28-29 11.6% 3.4% 15%

30-45 8.2% 6.8% 15%

46-47 11.6% 3.4% 15%

48-65 15% - 15%

EXHIBIT 7: WHY THE LEES NEED TO AIM HIGHER THAN THEIR $4.8 MILLION RETIREMENT CHECKPOINT

Our retirement checkpoint is designed to give the Lees an 80% level of confi dence in maintaining the same lifestyle as their working years. It’s based on these assumptions that refl ect what is fact or law today, not what could happen in the future:

• Income taxes will be lower during retirement, which may not be true given the Lee’s heavy reliance on tax-deferred accounts and the likelihood of tax reform.

• Social Security continues to replace the same level of income. However, if the system is reformed, couples in the Lee’s financial situation could get as much as 30% less.

• Health care costs and coverage stay the same, and the Lees incur no long-term care expenses.

• Investment returns are more normalized and do not reflect the possibility of a prolonged lower-return environment as the result of economic recession.

If, as anticipated, actual conditions are less favorable than some of these assumptions, the Lees would need more for retirement — ideally $1.5 million more, or $6.3 million in total. 8 Source: J.P. Morgan Asset Management, using The College Board, 2013 Trends

in College Pricing. Future college costs estimated to infl ate 5% per year. For illustrative purposes only.


Outcomes

The Lees successfully achieve both goals without ever exceeding a 15% savings rate. They accumulate their ideal $6.3 million for retirement, eclipsing the $4.8 million checkpoint and creating a comfortable cushion against the unknown (Exhibit 9). For college, their 529 accounts are able to fund 100% of the costs at four-year public universities (Exhibit 10).

Keys to success for the Lees include:

• Starting to invest in their early 20s, a lost decade for many savers.

• Consistently saving 15% of income throughout life, regardless of personal circumstances or market conditions.

• Building a diversified investment mix with the potential to generate 7% and 6% annual returns for retirement and college, respectively.

• Owning tax-advantaged accounts that allow them to keep more of their investment earnings and receive valuable company matches for retirement.

Save 11.6% for retirement Save 8.2% for retirement

$6.3 million

Checkpoint: $4.8 million

Save 15% for retirement

AGE 22 AGE 28 AGE 30 AGE 46 AGE 48 AGE 65

Child 1 Child 2 Child 1 Child 2

Birth of children College begins

EXHIBIT 9: RETIREMENT OUTCOME — EXCEEDING CHECKPOINT BY THE DESIRED $1.5 MILLIONVALUE OF RETIREMENT ACCOUNTS9

$89,920

$102,080 $106,725

$105,275

CHILD 1Total cost: $192,000


Total contributions Investment gains

10 Source: J.P. Morgan Asset Management. Charts are for illustrative purposes only and must not be used, or relied upon, to make investment decisions. College savings return assumption is 6% with a 2.25% infl ation rate. References to future returns are not promises or even estimates of actual returns a client portfolio may achieve. In all illustrations, numbers are shown in 2033 and 2035 dollars, are not absolute and may include rebalancing between accounts of child 1 and 2. For illustrative purposes only.

9 Charts are for illustrative purposes only and must not be used, or relied upon, to make investment decisions. Illustrated retirement savings checkpoint is sourced from page 15 in the 2015 Guide to Retirement for the $312,000 salary projected at age 65. Retirement investment return assumption is 7% with a 2.25% infl ation rate. References to future returns are not promises or even estimates of actual returns a client portfolio may achieve. For illustrative purposes only.

EXHIBIT 10: COLLEGE OUTCOME — FUNDING 100% OF COSTS10


THE TAXMAN TAKETH: A TAXABLE ACCOUNT FOR COLLEGE RESULTS IN $400,000 LESS FOR RETIREMENT

In this example, all of our assumptions are exactly the same as the baseline case with one exception. Instead of opening 529 accounts upon each child’s birth, the Lees invest in taxable accounts generating the same 6% returns. However, those returns are subject to annual taxes that cause them to earn less than they would with a tax-free 529 plan.11

Outcomes

Because their after-tax returns are lower, the Lees must increase college savings from 3.4% to 4.4% of income, or roughly an additional $1,400 per child in their first years alone (Exhibit 11). While this enables them to fully fund public schools (Exhibit 12), it has a negative domino effect on retirement because extra dollars going toward college means less into 401(k) plans. Compared to the baseline case, the Lees save a total of $61,414 more for college (pre-taxes), resulting in $400,000 less for retirement (Exhibit 13).


$79,712

$112,288 $117,398

$94,602





(TAXABLE) TOTAL

22-27 15% - 15%

28-29 10.6% 4.4% 15%

30-45 6.2% 8.8% 15%

46-47 10.6% 4.4% 15%

48-65 15% - 15%


Save 10.6% for retirement Save 6.2% for retirement

Baseline case:$6.3 million

$5.9 million






EXHIBIT 13: RETIREMENT OUTCOME — $400,000 LESS THAN BASELINE CASEVALUE OF RETIREMENT ACCOUNTS13


11 Earnings on non-qualifi ed withdrawals may be subject to federal income tax and a 10% federal penalty tax, as well as state and local income taxes. For illustrative purposes only. 12 Source: J.P. Morgan Asset Management. Charts are for illustrative purposes only and

must not be used, or relied upon, to make investment decisions. College savings return assumption is 6% with a 2.25% infl ation rate. References to future returns are not promises or even estimates of actual returns a client portfolio may achieve. In all illustrations, numbers are shown in 2033 and 2035 dollars, are not absolute and may include rebalancing between accounts of child 1 and 2. For illustrative purposes only.



$89,920

$102,080 $106,725

$105,275



HOME STEEP HOME: SAVING FOR A HOUSE AS WELL AS COLLEGE MEANS $1.2 MILLION LESS FOR RETIREMENT

What if the Lees don’t allocate all 15% of their savings toward retirement beginning at 22? At that early age, they may have other goals, such as buying a first home.

In this scenario, the Lees start saving 6% of annual income for retirement. The other 9% goes into a taxable account earmarked for a home and earning a conservative 4% in investment returns each year. At age 30, they have enough to make a 20% down payment on a house valued at slightly more than $400,000.

When their kids are born, the Lees must shift 3.4% of annual savings into a 529 plan for each child to reach their college funding goals. For the first two years, those savings reduce the amount going into their taxable account. After that, they reduce the amount going into 401(k) plans (Exhibit 14).

Outcomes

This example illustrates the difficulty of investing for a house, college and retirement with a 15% savings rate. The Lees are able to buy a home and fully fund public colleges (Exhibit 15), but it comes at the price of a less secure retirement. By redirecting significant savings toward a house in their 20s and toward college in their 30s and 40s, they retire with $5.1 million, or $1.2 million less than the baseline case (Exhibit 16). That may not be enough to maintain their lifestyle in a more uncertain future.


AGES RETIREMENTHOUSE

(TAXABLE)COLLEGE

(529 PLAN) TOTAL

22-27 6% 9% - 15%

28-29 6% 5.6% 3.4% 15%

30-45 8.2% - 6.8% 15%

46-47 11.6% - 3.4% 15%

48-65 15% - - 15%



Save 6% for retirement Save 8.2% for retirement Save 11.6% for retirement Save 15% for retirement

Baseline case: $6.3 million

$5.1 million


BUY HOUSE



EXHIBIT 16: RETIREMENT OUTCOME — $1.2 MILLION LESS THAN BASELINE CASEVALUE OF RETIREMENT ACCOUNTS15






$7.7 million


GIFTS MADE




EXHIBIT 18: RETIREMENT OUTCOME — $1.4 MILLION MORE THAN BASELINE CASEVALUE OF RETIREMENT ACCOUNTS18

GRANDPARENTS TO THE RESCUE: $130,000 IN COLLEGE GIFTS CREATES $1.4 MILLION MORE FOR RETIREMENT

Many families use 529 plans to make gifts and create lasting legacies, especially grandparents who tend to be in a better financial position to invest for college than young parents. As an added benefit, all gifts and investment earnings in a 529 plan are excluded from donors’ taxable estates, yet they retain full control for the life of the account.

How much can grandparents give without incurring annual gift taxes or using up part of their lifetime exemption? Normally, annual tax-free gifts are capped at $14,000 per beneficiary. However, 529 plans allow five years of tax-free gifts in a single year — up to $70,000 per beneficiary from individuals or $140,000 from married couples.16 In the Lee’s situation, one-time gifts averaging $65,000 at the birth of each child are enough to fully fund public college (Exhibit 17).

Outcomes

Gifts given to grandkids via 529 plans end up benefiting two generations of Lees. Freed from the responsibility of investing for college, the parents can save their full 15% of income for retirement from ages 22 through 65 — resulting in accounts

worth $7.7 million (Exhibit 18). Such a large margin of safety above their checkpoint gives the Lees flexibility and opportunity that might not have been available without the grandparents’ generous gifts. For example, they could divert some of their retirement savings to build an emergency fund, buy a home or pursue other financial dreams. Family gifting affords the Lees greater flexibility in the public college scenario, but is even more critical if the Lees aspire to private college educations for their children.


$65,000

$127,000 $147,000

$65,000





16 No additional gifts can be made to the same benefi ciary over a fi ve-year period. If the donor does not survive the fi ve years, a portion of the gift is returned to the taxable estate. For illustrative purposes only.



OUT OF BALANCE: FULLY FUNDING PRIVATE COLLEGE CAUSES A LARGE RETIREMENT SHORTFALL

Up to this point, all of our scenarios have involved public colleges, but many families aspire to give their children a private education. How would the higher expense affect college savings and, in turn, retirement outcomes?

Today, the average private college costs $40,900, more than twice as much as a public university. If the trend continues and prices rise 5% annually, the Lees would need:19



To meet this nearly $900,000 obligation, the Lees must contribute 7.5% of income per child to a 529 plan each year. Those high savings significantly reduce or completely eliminate the dollars available for retirement (Exhibit 19).



(529 PLAN) TOTAL

22-27 15% - 15%

28-29 7.5% 7.5% 15%

30-45 - 15% 15%

46-47 7.5% 7.5% 15%

48-65 15% - 15%

Outcomes

Fully funding private college while also achieving retirement goals may be unattainable at a 15% savings rate, even for relatively high earners like the Lees. In their desire to give children debt-free diplomas, they must reduce their retirement savings to 0% between the ages of 30 and 45. Not only do they stop funding their 401(k)s, they also lose out on valuable company matches during those critical 16 years.

Bottom line: Although the Lees succeed in meeting 100% of private college costs (Exhibit 20), their $4.2 million retirement account fails to reach even their minimum checkpoint (Exhibit 21). Do they have any other alternatives?

One option is to save an additional 6% of income in 401(k) plans between 30 and 45, which would maximize the company match and result in $5.8 million at 65. However, it also would drive up the Lee’s total savings rate to 21% during years when their household and child-raising expenses are likely to be high.

Another option is for grandparents to make the maximum tax-free gift of $140,000 into 529 accounts at the birth of each child. Those gifts would grow on a tax-advantaged basis to cover 97% of private college costs, with the remainder coming from parental income or student loans.



$198,824

$225,176 $235,423

$232,577




19 Source: J.P. Morgan Asset Management, using The College Board, 2013 Trends in College Pricing. Future college costs estimated to infl ate 5% per year. For illustrative purposes only.


FINDING BALANCE: PAYING FOR PRIVATE COLLEGE WITH A MIX OF SAVINGS, INCOME AND LOANS

Instead of fully funding private college with savings or gifts, perhaps a more realistic option is to use a combination of 529 plan assets, parental income and student loans.

In this scenario, the Lees reduce their 529 contribution rate from 7.5% to 4.6% of income per child. This allows them to continue funding 401(k)s and receiving company matches, even during their peak college savings years (Exhibit 22).

Of course, it also leaves them with a college funding gap. In an effort to limit their children’s student loan debt, the Lees plan to bridge this gap primarily with their own paychecks. However, given the large dollar amounts involved with private colleges, they may also need to consider other options such as scholarships or parental loans.


$4.2 million


Save 15% for retirement Save 7.5% for retirement Save 0% for retirement




EXHIBIT 21: RETIREMENT OUTCOME — $2.1 MILLION LESS THAN BASELINE CASEVALUE OF RETIREMENT ACCOUNTS21



(529 PLAN) TOTAL

22-27 15% - 15%

28-29 10.4% 4.6% 15%

30-45 5.8% 9.2% 15%

46-47 10.4% 4.6% 15%

48-65 15% - 15%




$5.8 million


Save 10.4% for retirement Save 5.8% for retirement Save 15% for retirement




EXHIBIT 23: RETIREMENT OUTCOME — $500,000 LESS THAN BASELINE CASEVALUE OF RETIREMENT ACCOUNTS23

Outcomes

The Lees accumulate $5.8 million for retirement, which is below their ideal amount but well above the minimum checkpoint (Exhibit 23). They will rely on three funding sources for private college (Exhibit 24):

• 529 accounts will cover 60% of the costs.

• Student loans will cover 12% of the costs, or roughly one semester of attendance per child, a level of debt that appears not only manageable but possibly even beneficial. Some families believe that giving children a financial stake in their education can help motivate them to study hard, graduate in four years and find a good job.

• Parental income will cover 28% of the costs, meaning it could be a lean six years for the Lees as they also continue to save 15%. Together with out-of-pocket tuition costs, a significant portion of their income will be dedicated to retirement and college, especially in the two years when both children are enrolled (Exhibit 25).


529 plan Income Loan

$118,840

$50,931 $56,151

$254,229$280,829

$131,020






EXHIBIT 25: USING INCOME TO PAY FOR COLLEGE AND SAVE FOR GOALS

Possible ways to ease the Lee’s financial burden

❍ Take bigger student loans, which increases the risk of overburdening children

❍ Take parental loans, which spreads out their liability but adds interest expense

❍ Encourage family members to give gifts for college

❍ Ask children to contribute to 529 accounts and work during college

❍ Apply for merit-based scholarships

❍ Apply for need-based financial aid, though the Lees may earn too much to qualify

AGES INCOMEOUT-OF-POCKET COLLEGE COSTS RETIREMENT SAVINGS COLLEGE SAVINGS TOTAL % OF INCOME

46 $204,692 $29,710 $21,288 $9,416 29.5%

47 $209,298 $29,710 $21,767 $9,628 29.2%

48 $214,007 $62,465 $32,101 - 44.2%

49 $218,822 $62,465 $32,823 - 43.5%

50 $223,745 $32,755 $33,562 - 29.6%

51 $228,780 $32,755 $34,317 - 29.3%


EXHIBIT 26: SUMMARY OF OUTCOMES

SUMMARY

Across every different scenario in this paper, the one constant and single most important investment behavior has been a consistent savings rate of 15% (Exhibit 26). The Lee’s strategies and priorities may change, but their commitment to save never wavers. From their first paycheck at age 22 through their last at 65, they remain steadfastly focused on long-term goals.

Those goals are highly interconnected. Changing the savings rate for college necessarily changes the rate for retirement, resulting in different outcomes for both. The key for investors is determining how to best divvy up their 15% based on unique family dynamics, financial needs and changing lifestyles.

As with any goal, retirement and college outcomes depend, in part, on factors outside an investor’s control. Examples include market performance and tuition costs as well as government policy regarding everything from taxes and financial aid to Social Security and Medicare.

The Lees wisely choose to concentrate on those factors within their control — when they start saving, how much they contribute and where they invest. By doing so, they’re able to find a successful balance between college and retirement.

$7.7M

$6.3M $5.9M $5.8M$5.1M

$4.2M

CHECKPOINT: $4.8 MILLION

Grandparent gift Baseline case(529 plans)

Taxable college account

Private college House down payment

Private college

Higher retirement confi dence Lower retirement confi dence

100% 100% 100% 100%60% 100%

PERCENT OF COLLEGE FUNDED BY INVESTMENTS

VALUE OF RETIREMENT ACCOUNTS

40% from loans & income

Opinions and statements of fi nancial market trends that are based on current market conditions constitute our judgment and are subject to change without notice. We believe the information provided here is reliable but should not be assumed to be accurate or complete. The views and strategies described may not be suitable for all investors. This material has been prepared for informational and educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.

J.P. Morgan Asset Management is the marketing name for the asset management business of JPMorgan Chase & Co. and its affi liates worldwide.

JPMorgan Distribution Services, Inc., member FINRA/SIPC.

© 2015 JPMorgan Chase & Co. All rights reserved.

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