When Funding Your Child’s Education, Let’s Not Repeat History

Key Takeaways

  • Student debt has doubled over the past seven years.
  • Newly minted 2016 graduates have an average of $37,000 in debt—some have debt loads in the six figures.
  • 529 plans are excellent, tax-advantaged ways for most parents and grandparents to save for a child’s education. Start saving as early as possible in the child’s life.

Student debt has more than doubled over the past seven years, to $1.3 trillion. As you might expect, 20-to-39-year-olds are shouldering the majority of that debt load. For instance, newly minted 2016 graduates have an average of $37,000 in debt, and we know many graduates who are facing several hundred thousand dollars in student debt. That’s a serious problem because it delays their financial independence.

The solution? Start saving for your kids’ (or grandkids’) educations as early as possible in their lives. There are several smart ways to do that.

  1. Set up a separate savings account at your bank that’s used just for educational expenses. Put money into that “bucket” consistently and you’ll be surprised by how much it builds over time. It’s convenient and flexible and provides you with full control.
  2. The Uniform Gifts to Minors Act (UGMA) allows you to act as your child’s (or grandchild’s) custodian. Contributors to UGMAs each can give up to $14,000 per year (i.e., the annual gift exclusion limit). Although UGMAs are taxable accounts, the money is taxed at the child’s (beneficiary’s) level, which is usually lower than the adult contributor’s rate. The downside of an UGMA is that it must be paid out to the child when he or she reaches legal adulthood (age 18 to 21, depending on your state). Also, UGMA accounts must be reported on FAFSA forms if you’re applying for student financial aid.
  3. Irrevocable trusts, which we will discuss in a future post.
  4. Section 529 plans, which were established in 1998, are state-administered education savings plans that can be either prepaid plans or savings plans. We’re discussing just 529 savings plans here, because they are the most versatile of the two options. The student and his or her parents and grandparents can each contribute up to $14,000 per year to the 529 plan—or you can fund the entire plan up front if you have the resources to do so. Like your workplace 401(k), most 529 plans offer savers a wide variety of stock, bond and mixed allocation mutual funds. The best part—529s are tax-deferred, and the distributions are tax-free if they meet the definition of qualified college expenses that you pay for your child. See my post about The Rule of 72 to learn more about the power of compounding over time. Learn why there’s such a big difference between tax-deferred and tax-free accounts. That’s very important when you’re talking about an 18-to-25-year time horizon for 529s.

Finally, if your child is lucky enough to get a scholarship, then you can transfer the 529 funds you have saved into another child’s or a close relative’s account as long as the money is used for educational expenses. Go to savingforcollege.com for more valuable info about college savings plans.

Until next time, enjoy.  Gary

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