Kids & Money Category
Dear Liz: I’m in my 50s. My kids have college loan debts that might total more than $200,000. I allowed them to take out loans because I expected to inherit $300,000 to help them pay off the debt. Now that inheritance will not happen.
I have $250,000 saved for retirement. When I’m 58 1/2 years old, I would like to pull that money out and pay some or all of these debts. Or use home equity. I’ve recently been downsized in employment, but I am looking to increase my income so I can help with their debt. Advice?
Answer: If your goal is to impoverish yourself so your kids will have to take care of you in your old age, by all means proceed with your plan. Otherwise, you need to rethink this.
You’ve been laid off in the middle of what should be your peak earning years. Older workers often have a tougher time than younger ones finding replacement jobs, even in a better economy than this one. You may not be able to replace your former income, which means you may not be able to add much to the amount you’ve already saved. You should be conserving your resources, including your home equity, and not squandering it repaying debts that aren’t yours.
And “squandering” is the right word. You may be able to avoid paying federal and state tax penalties on withdrawals under certain conditions; distributions made after age 59 1/2 avoid the penalties, as do those made if you’re “separated from service” if the job termination occurred in or after the year you turn 55. But you’ll still owe income taxes on the withdrawal, and those can be considerable.
Your children are the ones who will benefit from their educations. Those educations should allow them to earn incomes to repay these loans. The amount of debt they’ve accrued might be excessive — you didn’t specify how many kids, or whether this debt is being incurred pursuing undergraduate or graduate degrees. Ultimately, though, they will be in a better position to pay the debt than you are.
If you promised them help you can’t deliver, sit down with them now to break the bad news and strategize on how they can finish their educations without incurring substantially more debt.
Your story also should serve as a cautionary tale for anyone counting on an inheritance to pay future bills. Until the money is in your bank account, it’s not yours and shouldn’t be part of your financial planning.
Dear Liz: I am grandmother to two girls ages 10 and 14. I contribute to their Section 529 college funds and pay for expenses such as dental bills, dance lessons and so on. Is there a way I can deduct these contributions from my income tax?
Answer: Most states offer at least a partial tax deduction for 529 college plan contributions, said Mark Kantrowitz, publisher of the financial aid sites FinAid and FastWeb. The exceptions are California, Delaware, Hawaii, Kentucky, Massachusetts, Minnesota, New Hampshire, New Jersey and Tennessee, which have state income taxes but no deduction; and Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming, which don’t have state income taxes.
To get a deduction, you typically have to contribute to the plan offered by your home state rather than ones offered by other states. For more details, visit www.finaid.org/savings/state529deductions.phtml.
In general, you can’t take deductions for other expenses paid on behalf of your grandchildren. (If they’re your dependents — they live with you and you provide more than half their support — you could claim exemptions and possibly tax credits, but that doesn’t sound like the case here.) However, any medical or tuition expenses you pay directly on their behalf don’t count toward your annual gift tax exclusion, as discussed here last week.
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Dear Liz: Our 24-year-old son lives with us. He failed out of college, has been fired from two restaurant jobs and is working part time at a grocery warehouse. He has neglected to pay his credit card for several months. He also waits until his cellphone carrier threatens to turn off his phone before he pays half of that bill. We are concerned that his poor payment history may start to reflect on our good credit histories. We are retired and may want to build a new house. His bills are sent to our address, and creditors call our home phone number looking for him.
Answer: His debts shouldn’t affect your credit reports and scores unless you cosigned loans or other credit accounts or added him as a joint user to your credit cards.
Note the word “shouldn’t.” It’s possible that an unethical collection agency would try to get you to pay these bills by posting the overdue accounts on your credit reports. That could negatively affect your scores. Check your credit reports at least once a year at http://www.annualcreditreport.com. You also may want to consider ongoing credit monitoring, which can alert you if any collections or other suspicious activity shows up on your reports.
Speaking of unethical actions, you need to consider the possibility that your son could steal your financial identity. He probably has access to the information he would need to open new accounts in your name, including your Social Security numbers. His failure to pay his bills, even though it appears he can, indicates some moral shortcomings. He may not be low enough to rip off his parents, but if you have any suspicions about his trustworthiness, consider putting a credit freeze (also known as a security freeze) on your credit reports. This freeze should prevent anyone from opening credit accounts in your name.
Finally, you can write letters to creditors telling them to stop contacting you. You run the risk that such a letter could lead a creditor to sue your son. But his creditors may sue him anyway if he doesn’t respond to their requests for payment.
Dear Liz: My wife and I are planning to have a child in the next couple of years, and I realize that I have no idea how to go about preparing for that financially. How much cash should new parents try to have available? What else should we be considering?
Answer: Congratulations in advance on your entry into the great adventure of parenthood. The most important thing to know is that you can’t predict what’s ahead, financially or otherwise.
The U.S. Agriculture Department estimates that it will cost middle-income parents nearly $300,000 to raise a child to age 18. But your costs could be a lot less if you’re particularly frugal, or a lot more, particularly if you have a high income, plan to pay for private school or have a child with special needs.
You can get some idea of what to expect by using the Agriculture Department’s new calculator at www.cnpp.usda.gov/calculatorintro.htm.
Your annual food, clothing and healthcare bills typically rise $3,000 or more with each child. You also may opt for a bigger home or car, which can add to the bill. Child care and education are other considerable expenses.
Then there are the set-up costs. The authors of “Baby Bargains,” one of my favorite books about preparing for a child, say you easily can spend more than $6,000 just on equipment such as strollers, car seats, maternity clothes and nursery care. If you’re smart, however, you’ll try to spend a lot less, buying or borrowing used furniture and selecting well-reviewed, midrange brands of strollers and car seats rather than status brands.
You’d be smart to start trimming other expenses now and saving the difference, so that you have a fund to pay these start-up costs and so that the added expenses of a child don’t push you into debt.
If one of you is planning to stay home with the baby for an extended time, consider starting to live on one income now and banking the other.
Dear Liz: My husband and I are having a rough time making it from paycheck to paycheck. We make pretty good money. We have four children and end up helping them every month. We cannot seem to make it without going in the hole in our checking account. Could you please help me with what we should do?
Answer: As writer Erica Jong once said, advice is what we ask for when we already know the answer but wish we didn’t.
You know what you need to do: Cut off your children (assuming they aren’t minors, of course). If you can’t make it from one paycheck to the next, you’re in no position to help anyone else. Your children may not know the financial straits you’re in, or they may not care; either way, it’s up to you to close the Bank of Mom and Dad.
Once that financial spigot is shut off, you’ll need to look for the other leaks in your financial system. Track where your money is going using personal finance software such as Quicken, online tools such as Quicken Online, Yodlee or Mint, or a notebook and a pen.
If you’re still spending more than you make, you’ll need to find ways to cut back so that you not only don’t go in the hole but are putting aside money each month. You need to save for retirement and for an emergency fund, among other goals.
To do all this, you’ll need to use a word that apparently hasn’t been given enough of a workout around your home: “no.” “No, we can’t help you.” “No, we’re not going to buy that.” “No, I’m not going let my finances be in chaos because I can’t say ‘no.’ “
Dear Liz: My teenage daughter has a modest amount in a Roth IRA that has only a very small gain. I am thinking about using the principal on her private high school tuition so that the account is not considered when she applies for college tuition aid. Is this shortsighted?
Another factor is that I have inherited part of the estate of a relative. Although the transfer isn’t finalized, I probably will get the money during the same year that will be used to determine the financial aid for her first year in college.
Would she be better off if I left the Roth alone and used the inheritance? Or should I reduce the funds in her account?
Answer: Leave that Roth alone!
Retirement funds aren’t included in federal financial aid calculations. And it’s an awful idea to use retirement funds for educational expenses in any case.
Left alone, even a modest sum in a Roth can grow substantially, particularly because it will be 50 years or so before she reaches retirement. In that time, a $5,000 balance could grow to nearly $235,000, assuming she averages 8% annual returns.
Your inheritance will affect your daughter’s financial aid package, but perhaps not by as much as you think. The federal aid formula generally requires you to contribute less than 6% of your “discretionary” assets toward your children’s education.
Dear Liz: I’m a financial planner who liked your answer to the dad who wanted to fund his children’s IRAs but was shocked to see your recommendation (though with caveats) to purchase annuities.
I can’t imagine annuities would be suitable for children under any circumstances. Only under the best possible scenario of assumptions would an investment in an annuity—even a low-cost annuity—beat a reasonably tax-efficient mutual fund over any time period.
As long as money withdrawn from an annuity remains taxable as ordinary income, and as long as ordinary income tax rates are measurably higher than capital gains rates, this will be the case. I fear that brokers will be handing out your article as a tool to sell annuities for kids. To get an endorsement from someone of your reputation has probably helped some of them make this week’s sales goals. Let’s hope not!
Answer: Let’s hope not, indeed. Annuities tend to have high costs and do just one thing efficiently: turn capital gains that would otherwise qualify for low tax rates into ordinary income, which is taxed at a much higher rate.
Most investors would, as you point out, be much better off investing in index funds or other tax-efficient mutual funds.
However, annuities have one advantage that might appeal to this dad: They’re typically not counted in financial aid formulas, according to FinAid.org founder Mark Kantrowitz, because they’re considered retirement accounts. If the children don’t have enough earned income to fund IRAs, annuities would allow him to start saving for their retirements without having to worry about reducing their future aid packages.
This advantage may not outweigh all the disadvantages of annuities. But it’s something the dad should know about as he’s mulling over his options.
Dear Liz: We are facing a challenge in regard to financing our son’s education. We are being asked to contribute $30,000 a year for a private college education. Is this really a wise move? We have a daughter who will be in college in two years. Help!
Answer: A good education is virtually essential to success in today’s competitive, global economy. That said, there are plenty of ways to get a good education, and bankrupting yourselves on a too expensive college shouldn’t be one of them.
If you can’t manage this bill without sacrificing your own retirement plans or your daughter’s education, then you need to think about some options.
If your son has his heart set on this college, then he should be willing to take on at least part of the cost by incurring student loans. (He should be careful, though, to make sure that his total student loan debt doesn’t exceed the salary he expects to make in his first year out of school.)
Another option, obviously, is for him to attend a less expensive school for at least a couple of years, if not the duration of his education.
The fact that you’re asking this question just months before your son starts college indicates that you haven’t done enough thinking and planning, but it’s not too late.
Head to the bookstore or library and grab a copy of a college financing guide and explore your options. You might also use FinAid.org’s expected family contribution calculator, available at http://www.finaid.org , to estimate how much you’ll have to kick in once your daughter starts school.
Good luck.