By: Taylor Richardson, CRPS®, AIF, Financial Advisor
Before we get into how to save money for your children’s college, I want to make a point about your retirement savings. This may be a hard truth to accept, but if you’re not on track to fund your retirement, you won’t be doing your kids any favor by helping them pay for college. As parents we want to provide for our children, but the reality is that if you can’t afford to save for both college and retirement, you need to choose retirement.
If you retire without having saved enough money, you risk putting your children in a position where they have to help you financially. That help would probably be needed around the same time they’re dealing with the cost of raising their own children.
A better option is to fully finance your own retirement even if it means your son or daughter takes out student loans to pay for college. Student loans can be paid back over 40 years, and having secured your own financial position, you’ll have the option to help them retire the loan.
Earned Compensation with a Roth IRA
My preferred method of saving for college is through earned compensation, which is another way of saying you should hire your children to work at your practice. The money you pay them can go straight into a Roth IRA, which offers several tax benefits:
- It’s an after-tax contribution so all of contributions plus investment growth can be used tax-free.
- Because your child is an employee, the money you pay them is deductible, which lowers your state and federal tax liabilities.
- Contributions are taxed less because your child earns less. E.g. if you earn $200K and are in a 24% tax bracket, and your child is in the 10% tax bracket, you save 14% in federal and state taxes on Roth IRA contributions.
Another advantage of a Roth IRA is that it can be used for non-educational purposes. If your child ends up not needing all of the money in the account for college (Congratulations on your child’s full scholarship!) the remaining funds can be used for a first-time home purchase or to get a jump start on their own retirement account. As a custodial account, control of the Roth IRA will need to transfer to your child when they become an adult.
Remember, there are plenty of opportunities to employ your children. When they’re younger they can be hired as models for promotional photos, and teenagers can help manage your social media presence. The goal would be to start them out early and start building up their Roth IRA.
UGMA & UTMA Accounts
The state legislation that allows for gifts to children is the Uniform Gifts to Minors Act (UGMA) and the Uniform Transfers to Minors Act (UTMA). The chief difference between the two is that the UGMA is limited to financial products such as cash, stocks, mutual funds, bonds, whereas the UTMA can hold any form of property, including real property and real estate
The adult custodian – typically a parent – opens the account for a specific child. The adult can then add money or assets to the account and can choose investments. When the child reaches a certain age (generally between 18 and 25, depending on the state), assets and control of the account must be transferred to them.
The main advantage of UTMA/UGMA is that the money contributed to the accounts are exempted from paying a gift tax of up to a maximum of $16,000 for 2022. Plus, any income earned on the contributed funds is taxed at the tax rate of the minor who is being gifted the funds. As with the Roth IRA, the funds may be used for non-educational purposes in the event that the child doesn’t need all of the money in the account for school.
529 College Savings Plan
As a tax-advantaged savings plan, the 529 account is a popular option among parents. Like the Roth IRA, you make after-tax contributions and funds can be withdrawn tax-free, however the 529 plan can only be used to pay for qualified education expenses. The 529 plan also differs from the UGMA/UTMA and Roth IRA in that it can only be used for education, and it is always owned and controlled by the person who created the account.
If you have questions about how you can save for college while staying on track for retirement, schedule a call with our team at Engage Wealth Advisors. We help dentists prioritize their goals and then create plans to help achieve them.