Even as the economy begins its slow crawl back, college costs are continuing to rise – that means parents are continuing to fight a tough battle between funding college and funding their own retirements.

In October, the College Board reported that the average published price of tuition and fees for in-state students at four-year U.S. public colleges was $7,020 for the 2009-10 school year, up $429 or 6.5 percent higher than a year ago. After adjusting for inflation, the average net price paid for tuition and fees by public four-year college students overall is lower in 2009-10 than it was five years ago — but higher than it was last year. Private four-year colleges saw a smaller increase of 4.4 percent or $1,096, but for a much higher average annual tuition of $26,273 for the school year.

Also in October, the Employee Benefit Research Institute (EBRI) and the Investment Company Institute (ICI) also reported in October that American workers who held 401(k) accounts consistently from 2003 through 2008 suffered a 24.3 percent average drop in their account balance during 2008’s bear market.

Despite these huge challenges, it’s particularly important for parents to make retirement their first priority – kids can always take on loans and search for scholarship and grant funding to tide them over. Parents can offer help in a better economy, but the momentum lost in saving for retirement is much tougher to replace. But not so fast.

There are serious financial consequences to breaking into 401 (k) and other tax- advantaged retirement savings, and parents tempted to do so should look for other alternatives. A July 2007 Country Insurance and Financial Services survey found not only that 25 percent of respondents thought it would cost less than $50,000 to send a child to a four-year college (on average, public schools have surpassed that when you add room and board), but that nearly half believe that saving for college is more important than their retirement, which most qualified experts advise against.

Before you pick between yourself and your child by raiding your retirement accounts, here’s what you should know:

You’ll escape an early distribution penalty, but…

Any withdrawals from an IRA you might take for your child or grandchild’s education (as well as your own or your spouse’s) can be withdrawn without the usual 10 percent penalty on early distributions before age 59 ½. But you really need to talk with a tax advisor or a personal finance expert like a CERTIFIED FINANCIAL PLANNER ™ professional to determine whether your IRA withdrawals will have to be reported on your Form 1040.

You might hurt your kid’s chances for financial aid:

The entire withdrawal from an IRA — whether taxable or not — must be included as income on the following year’s application for the Free Application for Federal Student Aid, or FAFSA. Family income does more to influence financial aid than the size of the family’s assets, and dipping into your IRA can potentially damage your child’s potential financial aid. Check with a trained financial planner expert in financial aid strategy before you make a move.

Don’t even consider a ‘hardship withdrawal’ from a 401 (k) plan:

Earlier this year, the Transamerica Center for Retirement Studies reported an increase in workers taking loans from their 401(k) and other work-based retirement savings. Eighteen percent of those surveyed reported they took loans from their retirement plans in 2007 compared to 11 percent in 2006. Yet keep in mind that while most plans provide an option for hardship withdrawal for emergency medical or funeral expenses, the IRS restricts use of those funds for home purchases or tuition expenses.

So what do you do? Besides talking to a tax professional, it makes sense to find time to speak with a CFP^® professional to take a look at your overall financial situation so you can possibly find alternatives to raiding your retirement. A trained planner can help you look over all the spending, saving and investment decisions you’ve made so far and seal up the leaks – then you can discover whether you have smarter options to pay your child’s tuition. They include:

Starting a search for scholarships and grants with your kid:

See if there are grants and scholarships not only in your community, but also within your industry. Understand what a prospective student’s college choices might offer in terms of aid from its endowment. Also, some employers offer scholarships for their employees’ kids. Start searching online, at the office and by phone for such aid.

Fine-tuning your negotiating skills:

Parents need to become more aggressive about negotiating tuition, room, and board at colleges where either they or their children have been accepted. A financial planner with expertise in college planning can train parents to understand where those savings might be against the student’s qualifications for getting into the program of their choice.

December 2009 — This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Martin V Higgins, CFP, CLU, AEP, a local member of FPA.

I am sitting in a first class seat on a flight from New York to Los Angeles, a distance of some 2,600 miles. You are driving on the Long Island Expressway from its starting point in Queens to its end in Riverhead, New York – a distance of some 70 miles. Which of us is more likely to be killed before we reach our destination? And (for extra credit on the quiz) what is the mathematical relationship between the two probabilities?

The answer, of course, is that you are one thousand times more likely to buy the farm on your trip than I am on mine.

But it doesn’t feel that way, does it? A plane crash is everybody’s worst nightmare. On those exquisitely rare occasions that one happens, it will dominate TV news for days — unless, like the time the Concorde crashed, it’s on for weeks. A car wreck, psychologically, is something that happens to someone else. And, unless it’s particularly horrific, it won’t be covered in the media at all. So, because of its immediacy and terror, we intuitively regard death in a plane crash as being much more likely than in a car, when the opposite is overwhelmingly more probable.

This is simply the most obvious example of a systematic mental lapse that the psychologist who postulated it – the late Amos Tversky – called the availability heuristic. (A “heuristic,” in the jargon of behavioral psychology, is a consistent misapprehension of probability by a significant percentage of the population. For instance, if we flip a coin ten times and it comes up heads every time, we are strongly inclined to the belief that that the odds are overwhelming that it will come up tails on the eleventh flip. Instead, every flip is 50-50.) For purposes of this discussion, since neither of us is a Ph.D. in psychology, I wonder if we might just call it “the availability fallacy.”

The availability fallacy is very powerfully at work in people’s perceptions of financial risk. For instance, all of us have seen a one-day, 23% decline in the S&P 500, on October 19, 1987. But none of us has ever seen a one-day – or even a one-year – 23% increase in the Consumer Price Index. (Even in highly inflationary periods since WWII, that’s taken two years.) Market volatility is, by its nature, sharp, sudden and terrifying. Erosion of purchasing power is slow, insidious, constant…and all but invisible on any given day.

For this and myriad other reasons, Americans vastly overestimate the probability that equities will cause them to suffer catastrophic principal loss. And they even more abysmally underestimate the probability that, over three decades of retirement, erosion of purchasing power will grind down their lifestyle. This is the availability fallacy at its most dangerous.

The wise investor will constantly remind himself of this. One way is to remember that markets can and do go down suddenly and significantly…but they’ve never stayed down. There have, in fact, been three howling bear markets since the 1987 event – in 1990-91, 1998, and the great-grandfather of all postwar bears in 2000-20002. Yet the S&P is today about seven times higher than it was at the end of the 1987 decline. The effect of the declines has been negligible to nonexistent, in the career of the long-term investor.

By the same token, inflation very rarely goes up much in any one year…but it virtually never stops going up. The cumulative effect of this observation may clearly be seen, if you simply juxtapose a 15-cent first-class U.S. postage stamp issued to celebrate the 1980 summer Olympics with a brand new Frank Sinatra commemorative 42-cent stamp.

In 1980, again in 1987, and again in 2008: the long-term, planning-oriented investor was and is well advised to worry much less about loss of principal than about erosion of purchasing power. The availability fallacy causes most people to do the opposite. Don’t be one of them.

© 2009 Nick Murray. All rights reserved. Used with permission.