College tuition is at an all-time high. As of 2022, the average student loan debt is about $39,000 per student, and the average monthly student loan payment is nearly $400.1 It’s no wonder parents want to help their children pay off their student loans as quickly as possible. Paying off this debt could help set your child up for success as they make important financial choices, such as applying for a mortgage.
But is paying off your child’s student loans early always the best option? Here are five things to consider when deciding whether to help your child pay off their student loans.
Consider Any High-Interest Debt First
Before helping your child pay off their student loans, you should consider if you have any high-interest debt yourself. Generally, student loans feature a moderately low-interest rate (around 4%-7% depending on the loan).
If you have debt at a higher interest rate, such as credit card debt or a personal loan, you may want to consider paying off that debt first before helping your kids. Prioritizing debt repayment by interest rate can help you decide whether you should help pay off student loans or other debts first.
Your Payments May Qualify As Tax-Free Gifts
Some parents may want to pay off their child’s student loans but are afraid of triggering a gift “tax”. Luckily, there are a few ways around this “tax”.
According to the IRS, the tuition you pay for someone may qualify as a “non-taxable” gift.2 However, this is applicable only when the payment is made directly to the school or university. With that in mind, if your child has any student loans that were issued by the university, payments towards these expenses may be tax-free. Talk to your CPA or a tax professional to be sure.
Another way to avoid this gift tax is to stay within the gift tax exclusion for the year. In 2022, the gift tax exclusion is $16,000.3 This means that each parent can give up to $16,000 a year ($32,000 total). As long as your gift stays within these parameters, you shouldn’t have to pay a gift “tax”. An important aspect to note is that even if you exceed the gift tax exclusion, it is very unlikely that you will have to actually pay a tax out of pocket. Each individual has a gift and estate lifetime exclusion amount ($12,060,000 in 2022). When someone makes a gift above the annual exclusion ($16,000) it will reduce that individual’s lifetime exclusion amount ($12,060,000).
Discuss A Repayment Plan
If you are worried about your child’s ability to make their student loan payments on time and want to help, it might be worth having a conversation with them, as well as their lenders, to see if there are any repayment plans available. Most loans, especially federal student loans, offer repayment plans that can be stepped up or down depending on your child’s income.4
Research Loan Forgiveness Options
In addition to student loan repayment plans, there are also some loan forgiveness plans available that your child might qualify for.5 For example, there are student loan forgiveness options for students who pursue certain careers in the public sector.
In the wake of the COVID-19 pandemic, the government rolled out more forgiveness options, including COVID-19 Emergency Relief. Before you create a plan to help pay off your child’s student loans, see if they qualify for loan forgiveness. As of this writing, federal student loan repayment will resume on September 1, 2022.6
Don’t Forget Retirement
As important as it is to take care of your children, it’s also important to take care of yourself. As you get closer to retirement age, it might make more sense to contribute the money you would have used for your child’s student loans to your retirement savings. Your children have long careers ahead of them to make payments on their loans. As your earning years come to a close, it’s important to prioritize retirement savings because you won’t be able to work forever.
Paying off your child’s student loans is a generous thing to do, and it might make sense for your financial situation. Before diving in completely, it’s important to consider possible repayment plans, loan forgiveness, tax implications, and other debt and savings goals.
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