Should parents save for kids' college – or their retirement?

Diane Lim Rogers started thinking about how to pay for college almost as soon as her children were born. She's an economist. It's what she does.

But recent changes in the economy mean that Ms. Rogers won't be able to finance her children's education by borrowing against her retirement savings and home equity, as she had planned. Both were hit hard in the last few years. So she's thinking about doing something that makes investment advisers shudder: pulling money out of retirement accounts to help pay tuition.

It's a dilemma older than the 401(k). Should parents pay for college or save for retirement?

The choice has only gotten harder since the great recession. While the economy has turned south, college costs have continued to mount. Average tuition rose 4.4 percent last year for private colleges; 6.5 percent for public (in-state) schools. Harvard will cross the $50,000 mark for tuition and room and board starting this fall.

Many parents cringe at the idea of saddling children with that much debt, even though their own household income has been falling since 2006. Those with children in high school, like Rogers, are on track to cover only about 11 percent of their children's total college costs (including room and board), according to a recent study by Fidelity Investments.

Put another way: If Americans withdrew every last dollar invested in state 529 savings plans, accounts specially geared toward saving for educational expenses, and divvied the funds up evenly among all US undergraduates last year, the average college student would have been able to pay for only one semester of one year at an in-state public university – or less than two months at a private college. Even with the average federal aid grant, the 2008-09 freshman would have come up short – $21,600 short in the case of a private university (see chart).

No wonder so many parents are tempted to step in: with just a little dip into the retirement account. Education is important and that's what parents do – put their children first, right? But for financial planners, the issue is black and white: Parents should absolutely not pull money out of their retirement funds to pay for their children's education.

"Children can get a loan for college, but that's not something you can get when you retire," says Michael Garner, vice president and financial consultant for Charles Schwab. "You may wind up being financially dependent on them later in life and that's not doing them a favor."

Instead, parents should innovate.

"More and more people are employing creative strategies to bridge the gap [between the cost of college and what their savings will fund]," says Joe Ciccariello, vice president of college planning at Fidelity Investments.

That could include having children work part time, live at home as undergraduates, attend public colleges, or finish in fewer semesters. There are many ways parents and students can start saving.

But again, financial advisers are adamant: Fund retirement before salting money away for children's college costs. How much families should save for those golden years will vary with income, retirement goals, and the amount of time remaining until retirement. At a minimum, parents should contribute enough to their 401(k) plans that they get the full match their firm offers, says Mr. Garner. But most will need to do more than that.

Once retirement needs are met, parents can set up a college savings plan with what's left over. A 529 plan will be the best option for most people, these advisers say. Its main benefit is that after-tax contributions can be invested and, as long as they are used for a qualified education expense, withdrawn without paying taxes on the earnings.

Another benefit is that the funds can easily be transferred between family members. The maximum contributions are much higher than with other accounts, typically about $250,000 over the life of the account.

But for many families, saving for college remains a hurdle.

"I never felt like I had enough extra to save in a separate college fund," says Rogers. She and her husband make a good income, but they have four children and the expenses just seem to pile up. "Now my daughter is about to graduate from high school and two sources of wealth I was planning to tap into have evaporated."

Another part of Rogers's plan was to live in a state renowned for public higher education. Her daughter, Allie, was recently admitted to the University of Virginia, the second best state college in the United States, says U.S. News and World Report.

But then Allie discovered Dartmouth College in Hanover, N.H. She thought the school was a perfect fit. She's been accepted there, too.

Rogers says she can swing Virginia's in-state tuition, but Dartmouth would add roughly $126,000 to her four-year costs. Rogers has another daughter just 16 months younger than Allie and two more children in their early teens.

"The cost difference [between the schools] is easy to quantify, the difference in benefits is much less so," says Rogers. "It's, at best, very fuzzy math. And yet it's something I want Allie to think about … especially the fact that a lot of that debt will be on her."