By Janet Stanton Burt
A wealthy couple recently asked the financial experts at Money magazine whether helping their daughter pay off her student loans would trigger the gift tax, and wondered how to avoid it.
Few parents these days have the wherewithal to gift a child more than the $14,000 annual limit ($28,000 for married couples) that would trigger the tax. But we’d ask a more fundamental question: Should parents be paying off their kids’ student loans at all?
Saving is Cheaper Than Borrowing
Let’s remember: It costs money to borrow money. Ponying up thousands of dollars to help pay off student loans once a child has graduated is significantly more expensive than investing money in a 529 plan when your child is young.
Thanks to the power of compounding (when your returns are reinvested and earn more returns), investments made early in your child’s life can significantly increase in value. Meanwhile, the interest on student loans means you could repay thousands more than the actual amount borrowed.
Even if your child is already nearing high school age, it’s not too late to start saving. Your investments won’t have time to grow as dramatically as if you’d started when your child was born, but every dollar you’re able to save is a dollar you — or your child — won’t need to borrow and repay with interest.
Put Yourself First (Really!)
Most parents, including the ones who asked the Money question, tend to put their kids’ interests ahead of their own. But don’t throw every spare dollar you have at your child’s college fund trying to avoid loans. First, set a specific retirement goal, and make sure contributions to your 401(k), IRAs and other retirement accounts are on track. Saving for college should fit in with, not override, your other financial goals.
Prioritizing your retirement over paying your child’s college bills doesn’t make you selfish, it means you’re financially smart. If you aren’t able to save enough to cover the balance once your child enrolls, remind yourself that she’ll have many options to finance college, including:
- Scholarships and merit aid.
- Money from internships or work study programs.
- Gifts from grandparents.
- As a last resort, student loans.
You won’t have the same array of options to fund your golden years.
A Note About Loans
What if your child graduates with loans and you’d like to help out? You’re in good company. About 3 in 5 parents of graduates said they plan to help their kids with student loans, a 2016 Discover survey found. It’s natural for parents to want to help their debt-burdened graduates, but again, repaying student loans for the younger generation could be a financial mistake if done at the expense of your own retirement savings.
As long as you’ve done the math and you know what impact helping your kids will have on your own retirement bottom line — really know, not just guess — then you can make an informed decision about whether to help your children with burdensome student loans.
You might also want to consider other ways to help your new grad that stop short of taking over loan payments entirely, including:
- Letting your college graduate live with you, while they concentrate on paying off loans quickly themselves.
- Matching their loan payments, for example contributing $25 or $50 for every $100 they pay.
- Helping your child figure out better repayment options they can handle on their own (like income-driven repayment options).
Be Wary of Co-signing
It may be true, as the Money adviser suggests, that parents can avoid the gift tax by co-signing a child’s student loan and then paying off the debt, but co-signing student loans can be a dangerous proposition for parents.
You’re equally responsible for the debt with your child, and that debt could harm your ability to borrow more money later, say to buy a car or to refinance a mortgage. If you intend to help your child with the loan (rather than pay the whole thing outright), any late or missed payments on your child’s part could negatively affect your credit score.
Even though college costs can be daunting, there are ways to help your child achieve her ambitions, and repay her education debts, without compromising your future financial health. You might be giving a more valuable gift to your child by ensuring your nest egg is in sound shape, so you won’t need to turn to your kids for help when you run out of money in retirement.
Goal Investor can help you juggle your competing financial priorities, set realistic targets and make progress toward all your investment goals.
This information is provided for educational purposes only and is not intended to provide investment or legal advice. SEI does not claim responsibility for the accuracy or reliability of the information provided.
Neither SEI nor its affiliates provide tax advice. Please note that (i) any discussion of U.S. tax matters contained in this communication cannot be used by you for the purpose of avoiding tax penalties; (ii) this communication was written to support the promotion or marketing of the matters addressed herein; and (iii) you should seek advice based on your particular circumstances from an independent tax advisor.