Financial Planning for Parents and Guardians
Eileen St. Pierre, The Everyday Financial Planner
I have been getting a lot of questions lately from anxious parents, grandparents, and guardians who worry about saving money for their children. They want to make sure it is put into the right accounts so they do not jeopardize their child’s chances of getting financial aid if they decide to go to college. They also want to make sure their kids are able to use the money for whatever career path they wish to pursue. Here are some financial planning tips for parents and guardians.
First and foremost, save for your own retirement!
Then put any excess contributions towards saving for your children’s college educations. According to the 2014 Walmart Moms Research Project, 39% of mothers surveyed prioritize saving for their children’s college over saving for their own retirement. While there are other ways for your kids to pay for college, you do not want your kids to have to support you in your retirement (which hopefully will last a lot longer than your child’s time in college). Having your child pay some college costs will help him/her realize the value of his/her education.
If applying for need-based financial aid, it is better for assets to be in the parent’s name.
Savings accounts you open at the bank (UGMA accounts) or an investment company (UTMA accounts) are considered assets of the child and will count against him/her when determining financial aid eligibility under today’s federal formulas. The best option here is a 529 plan.
- These are tax-deferred plans and withdrawals are tax-free if used for qualified higher education expenses.
- You may even get a state income tax deduction (sorry, no federal income tax deduction).
- You can sock away a lot of money for your kids – generally $300,000 per child.
- Visit my column C is for Coping with College Costs to learn more about 529 plans.
You also need to consider how your child will use the money.
If you want your child to have complete control of the money when he/she reaches legal age, then a UGMA or UTMA account is the way to go. This may be a blessing or a curse. You, the parent or guardian, may not make the same choices as your child. But they can spend it on whatever they want – a gap year in a different country, their own brewery business, or a new car.
If you want your child to spend the money on higher education expenses, then go with a 529 plan. You need to use the funds for qualified higher education expenses or pay income taxes and a 10% penalty on withdrawals. But your child need not use the account right away and can use it for graduate school later on if funds are still available.
Another option is a Coverdell Education Saving Account (ESA), which functions a lot like a Roth IRA. Its primary benefit is you can also use the money for qualified K-12 education expenses. Unless you have a child with special needs, I personally feel this benefit of an ESA is far outweighed by its disadvantages.
- You can only contribute $2,000 per year, per child – up until the child turns 18 (you can contribute longer to a 529 plan). The IRS imposes a 6% excise tax on excess contributions.
- Part of the withdrawal may be taxable if you claim education tax credits.
- SavingforCollege.com has more information on ESAs.
Protect your children in case something happens to you.
Don’t forget this part of your financial plan. A will is the only place where you can name guardians for your children. You may also need to name a conservator to manage money until your children reach legal age. Ask an attorney if you need to establish a trust (for example, if your child has special needs). Make sure your insurance needs are up-to-date.
- Consider long-term disability insurance – it can replace 50-60% of your income.
- Make sure you have enough life insurance to cover your mortgage, other debts, and your children’s future education expenses. A rough rule of thumb is to multiply your annual income by 10 and add $100,000 per child.
- Visit my Estate Planning page for more information.