More ways to get around gift taxes
Dear Liz: I’m an estate-planning attorney and want to expand on the answer you gave to the parent who wanted to give her children money for their educations or a car but was worried about gift taxes.
Your explanation of the federal rule was accurate — only gifts of more than $13,000 per recipient have to be reported, and gift tax isn’t owed until amounts over that exclusion exceed $1 million — but state laws vary. (California levies no gift tax.) In addition, the $13,000-per-person annual exclusion and the $1-million lifetime exclusion is available for each giver, so a married couple could give $26,000 without reducing their lifetime exemptions.
Also, tuition is not considered a gift if paid directly to the school, irrespective of the amount, so the giver could offer to pay tuition directly and then give money separately for a car. Finally, 529 college savings plans are an excellent way to save for a child’s higher education and are often preferable to giving money directly to the children.
Answer: Thanks for the additional information. College savings plans allow people to contribute up to five times the annual gift exclusion amount at one time, meaning generous parents or grandparents could stow $65,000 into a 529 plan in one lump sum (as long as they make no other gifts to the recipient in that five-year period).
This college education may not be affordable
Dear Liz: My daughter is a sophomore at a very expensive college, and federal loans cover only $6,500 of her costs. She has taken out two private student loans with me as a cosigner, one at 6.5% interest and the second at 9.9%. I need $15,000 more for this semester’s tuition. I am an unemployed single mother but cannot get much financial aid. She is an above-average student but cannot find any awards or scholarships.
Answer: Your daughter may need to look for a less expensive education, since it appears neither of you can really afford the one she’s getting.
Unlike federal student loans, private student loans tend to be expensive, with variable rates and less flexible repayment options. Borrowers can easily find themselves taking on far more debt than they will be able to repay after graduation, yet this debt typically can’t be discharged in bankruptcy — it can follow your daughter for life.
A better option, if you must borrow, is for you to take out PLUS loans. These are federal loans for parents and graduate students that allow you to borrow the difference between your daughter’s college costs and any financial aid, including federal student loans, she gets. The rates are fixed at 8.5% or less.
PLUS loans do require a credit check. If you don’t pass — you’re 90 days or more overdue on a bill or you’ve had a bankruptcy in the last five years, for example — your daughter’s eligibility for student loans would be increased somewhat to help compensate.
But both of you should be thinking about alternatives. You really shouldn’t borrow money if you don’t have a way to pay it back. When you’re unemployed, taking on $15,000 a semester in debt is pretty foolish.
If her school won’t reconsider her aid package in light of your unemployment, she should be researching less expensive schools to which she could transfer her credits.
529 college savings plans are a good option for many
Dear Liz: I have twin boys and have been looking for a college fund to set up for them. Most bank saving accounts don’t pay much interest. The only thing I have found that is halfway decent is a certificate of deposit. My grandmother set up a trust for me, but I don’t know whether that’s a good idea these days. Do you have any ideas that would help?
Answer: You’re actually asking two questions. The first is what vehicle to use for college savings, and the second is how to get a decent return on your money.
Let’s take the latter question first. Bank savings accounts or certificates of deposit are fine if your kids are headed off to college in a year or two, but these low-risk investments won’t give you much growth on your money. In fact, you’ll almost certainly lose buying power over time when you consider inflation. If your money is in a taxable account, you’ll lose that much more.
Many parents opt to take more risk in order to accumulate more funds. If college is 10 years or more in the future, investing at least some of the money in stocks or stock funds makes sense.
The vehicle you use is also important. If you expect to get financial aid, you’d be better off avoiding custodial accounts such as Uniform Transfers to Minors Act (UTMA) or Uniform Gift to Minors Act (UGMA) accounts. These were popular accounts years ago when tax rates were higher, but they count heavily against you in financial aid formulas.
Many families find 529 college savings plans to be the best choice. These state-run accounts allow your contributions to grow tax-free for college and are treated favorably in financial aid calculations. These plans typically offer a choice of investment options, including age-weighted options that start out more heavily invested in stocks but that ratchet back exposure to risk as college draws closer. For more information, visit SavingForCollege.com.
Should you tap your HELOC while you still can?
Dear Liz: Are banks still lowering the amount of available credit? I’m concerned because we were hoping to use our home equity line of credit to pay for our children’s college educations, if need be.
Our current balance is less than 5% of the total available limit, but my credit reports show our credit line lender recently reviewed our credit history. I am concerned that our bank will lower our available credit as my son is about to start college. Are my concerns valid?
Answer: Perhaps. Lenders have been reducing home equity lines of credit as home values drop. If your mortgage balance and your line of credit total more than 60% of the current value of your home, you may be at risk of having your limit reduced right when you planned to use it.
If that’s the case and your son is heading off to school in the next year, it might be prudent to withdraw the money now and keep it in a savings account.
If college won’t start for several years, though, you might want to explore other options, since it’s generally not a good idea to borrow money so far in advance of when you’ll need it.
Fortunately, you have plenty of options when it comes to paying for college. Just make sure you fill out a Free Application for Federal Student Aid. Even if you don’t qualify for need-based aid, filling out the FAFSA will allow you to apply for federal student loans. Your son can get Stafford loans at a 6.8% fixed rate and you could get PLUS loans with a fixed rate ranging from 7.9% to 8.5%. Although the amount of student loans your son can get is generally limited to $31,000 for an undergraduate degree, PLUS loans allow you to borrow whatever you need to cover any costs not paid for by the student’s financial aid package.
If you can save for college, you should
Dear Liz: I would like to know how best to use a $100,000 inheritance. I am a stay-at-home mom, age 46. My husband, 42, earns $100,000 a year.
We owe $132,000 on our house and have no other debt. We pay off our one credit card in full monthly. He puts the maximum into his 401(k). We have two sons, ages 5 and 8.
Should we use the money to pay down our mortgage? I’m not interested in saving for college. We will be retiring about the time the kids are ready for college and we plan to have them take out student loans.
Answer: If you can save for college, you probably should.
College costs show few signs of moderating, so your older child might face a bill of $140,000 for an in-state public college or $200,000 or more for a private or selective public college. The cost for your younger child will be even higher. If they borrow the entire cost, they’re likely to remain financially disadvantaged for years. Students who overdose on loans often can’t save enough for retirement and delay starting families and buying homes because of their debt. Anything you save for them could reduce that terrible burden.
You also might want to rethink the idea of retiring when they start college. Even if your husband has been maxing out his retirement fund, it’s unlikely he’ll have saved enough by age 52 to last the rest of your lives, particularly if you have to start paying for health insurance on your own. (Medicare isn’t typically available until you’re 65.)
You didn’t mention savings. Most people should have an emergency fund equal to three months’ expenses, but families with just one earner typically should shoot for six or even nine months’ worth.
In any event, you almost certainly have better things to do with your money than pay down low-rate, potentially tax-deductible debt such as a mortgage.
A better approach might be to divide your inheritance into thirds, investing a third into an emergency fund, a third into your boys’ educations and a third into retirement funds.
A visit to a fee-only financial planner could help you sort through your options and clarify your goals.
