As college costs continue to rise, it’s becoming increasingly difficult for students to pay for it themselves. The total student loan debt in the United States has risen to a staggering $1.75 trillion (opens in new tab). This has led many parents and grandparents to want to help carry a portion of their child’s or grandchild’s college debt. They shouldn’t jeopardize their own financial future by entering retirement with someone else’s student loan debt, though.
Even so, the number of adults over the age of 62 with student loan debt has reached a startling 2.4 million borrowers (opens in new tab). If parents and grandparents plan on helping to pay for college, they need to plan ahead to stay debt-free in their golden years. There are many ways they can start planning now to help with college costs while still saving for their retirement.
529 plans offer tax advantages
529 plans are investment accounts that can be used to pay for education for a specific beneficiary. Choosing a 529 plan also comes with tax benefits. It will grow federal tax-free and will not be taxed (opens in new tab) when the money is taken out. It’s important to note that you can use a 529 plan from any state to help cover education expenses in any other state. However, depending on the state you live in (opens in new tab), you may qualify for even more tax deductions with a 529 plan. There are seven states that provide a state income-tax break for any contributions to a 529 plan: Arizona, Arkansas, Kansas, Minnesota, Missouri, Montana and Pennsylvania. There are no contribution limits for 529 plans, but there are limits for the tax deductions. These plans can be used for more than just college tuition.
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For example, they can help cover student loan repayments and college expenses such as books or meal plans. You can even use them to help pay for K-12 tuition costs. While a good option, 529 plans do come with a few disadvantages (opens in new tab). If you are looking into financial aid for college, 529 plans can work against you. You can also run into higher fees with these plans. These downfalls could be why many are hesitant to use these plans for college.
Educational savings accounts are a little different than 529 plans
A Coverdell education savings account (ESA) (opens in new tab) is very similar to a 529 plan. The earnings in this account can grow tax-deferred, and withdrawals are tax-free when used for educational purposes, as they are in a 529 plan. However, the beneficiary will have to pay taxes on any distributions that exceed their qualified educational expenses. You can contribute only $2,000 per year, per beneficiary, so if you exceed that amount, the rest will be taxed. While very similar, there are a few differences between an ESA and a 529 plan. Contributors must earn less than $110,000 annually, they cannot contribute to the account after the child turns 18, and the money is automatically distributed when the beneficiary turns 30. An ESA may be a better option than a 529 plan if the contributor wants to give the account over to the beneficiary as they grow older.
Tax-free gifts are an easy way to go
Grandparents can also simply give cash directly to either the child or parents. To avoid the federal gift tax, you can make a tax-free cash gift (opens in new tab) of up to $16,000 per recipient in 2022. This means if you give away anything less than $16,000 to an individual, you and your beneficiary do not have to report that to the IRS. If you decide to go this route, make sure you discuss the exact tuition and any other college expenses with your grandchild or child, and then form a detailed plan on where exactly the money will go. This will help make sure that the money you are giving is going toward college expenses, such as tuition, rather than something else.
Help your family the smart way
No matter if you’re helping save for a family member’s college expenses or saving for retirement, consulting with a financial planner should be your first step. They can help you come up with the right plan for you to save for college, retirement and everything in between.
This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.
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