Smarter Ways to Help Your Kids Pay for College

The trend toward putting off having children means many parents are facing their kids' tuition bills when they are hitting their 60s and about to retire.

While it is natural to want to help, parents with limited years of income and savings ahead could be putting themselves at risk of running out of money.

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Dongyun Lee

Of all the options available, there is one to avoid at all costs: co-signing a student loan.

It might seem tempting, since it means putting up no cash upfront, and co-signing lowers the interest rate—in some cases by as much as five percentage points on private loans.

Lenders aren't dumb: Having a co-signer virtually ensures repayment, because there are now two parties on the hook for a loan that is almost impossible to default on.

Unlike other loans, student loans generally can't be discharged in bankruptcy, and with private loans you would be on the hook even if your child became totally disabled or died.

What's more, late or missed payments will hurt your credit, so you might find yourself in an unenviable position of monitoring and nagging your child to avoid delinquency.

Here are some alternatives—though none is perfect.

The Social Security Option

One option, if you are at least 62 and have dependent children or stepchildren living with you, is to begin taking your Social Security benefits early.

Dependent children younger than 18, or up to age 19 if a full-time student in secondary school, may each receive an additional monthly payment equal to up to one-half of your full benefit.

There is a limit to the amount paid to you and your family. The limit varies, but is generally equal to about 150% to 180% of your retirement benefit. The money can be used for any purpose, including college.

One scientist at a consulting firm in Bellevue, Wash., who turned 62 last November, still has a 10-year-old and a 12-year-old at home, each of whom qualifies for 50% of his benefit until they graduate from high school.

He estimates that his children will receive a total of $150,000 by the time his youngest graduates from high school—money that he plans to use to help cover college costs.

The trade-off—besides requiring that your kids live at home—is that taking benefits early locks them in at a lower amount. But for some, this may be worth it.

'I'll Take Those Odds'

When Jim Miller, a college athletic director in New Orleans, retired at age 62 in 2010, his accountant calculated that collecting benefits for his children, then ages 13 and 15, would put him ahead until he reaches age 79. "I'll take those odds," he says.

Couples have more options. One spouse can begin collecting Social Security benefits at age 62, enabling dependent children to collect half their benefit, while the other waits until full retirement age to take benefits.

Another possibility for people who reach full retirement age, typically 66, is to file for benefits and suspend them. This enables dependent children to collect benefits on the parent's earnings record, yet allows the parent's benefit to rise with delayed retirement credits until age 70. This will increase not only his benefit, but the benefit a surviving spouse ultimately collects.

Tapping Your 401(k)

Another source of cash, if you still are working, is to take a loan from your 401(k) or 403(b) plan.

This can be risky, but there are benefits. You can borrow up to half the account's balance, up to $50,000, and repay yourself at a low interest rate, typically prime plus one to two percentage points. You have five years to repay the loan.

However, if you lose your job, the loan must be repaid within 60 to 90 days, or else it will be treated as a distribution and subject to income taxes, though not a 10% penalty if you are retired and over age 55½.

Another downside: Such distributions boost your income, which could affect your child's eligibility for financial aid.

If college is more than five years away, consider opening a Roth IRA. When your child starts college, you can withdraw your contributions, tax and penalty free.

If you are over 59½, earnings also are tax and penalty free, as long as the account has been open at least five years.

Write to Ellen E. Schultz at ellen.schultz@wsj.com

A version of this article appeared May 19, 2012, on page B9 in the U.S. edition of The Wall Street Journal, with the headline: Smarter Ways to Help Your Kids Pay for College.