Money for College: Should I lend money to my kids for college

The US college debt bubble is reaching dangerous levels. It comes as no surprise that some parents have plans to loan their kids money for college.

That raises a question… Does the IRS care if you loan money for college to your kids?

Generally speaking, no. The IRS isn’t really concerned with personal loans to your children. They don’t care about how often you lend money to them, or whether you charge interest. I also doubt they care if you get paid back.

Lending money to your kids for college is a different story. While this is a nice sentiment, take my advice and make this an IRS friendly loan.


You should charge interest

If you loan a significant amount of money to your kids, it’s important to charge interest.

It will keep the IRS at bay and encourage your child to work hard on their college education. Graduating on time is crucial to keeping college costs down. In Connecticut, taking five years (the average) to complete a four-year degree can cost you an extra $49,350 to $64,965.

A study titled, “More is more or more is less.”, by, Laura T Hamilton shows how larger contributions from parents are linked to lower grades among students at a variety of four-year colleges.

“Parental aid decreases student GPA… students with parental funding often perform well enough to stay in school but dial down their academic efforts.”

The study clearly shows that if you want your kids to get better grades and graduate on time, don’t pay for their education. And if you do help, charge them interest.


Charging your son or daughter interest may strike some people as ungenerous.

It’s not.

One of the purposes of college is to prepare your child for the real world. This is a great opportunity for you to show your son or daughter the power of compounding interest without them tied to a high interest rate.

They might think twice about accepting a credit card with 19% to 21.99% APR

Kelly of Cheshire, CT shares, I have done this with my parents several times over, and have paid interest each time. I have done this with them since I was a teenager – everyone’s financial beliefs and circumstances are very different, and there really is no wrong answer here. From my experience, and because this was something that was started when I was young, it was financially a great lesson each time and I’m glad they did it that way with me.”

Here’s the bottom line. If you don’t charge interest, the IRS could “impute” interest on the loan. They’ll treat it as though you earned the interest anyway and will require you to report it as taxable income. In other words, the interest that you should have charge will be seen as a gift and apply it to your annual gift-tax exclusion limits.

You can avoid all the tax complications by having a written loan agreement and by charging the IRS-approved applicable federal rate (AFR).


IRS-Approved Interest Rates on Money for College

Many parents in my community said if they could, they would give their child an interest-free loan for college. Or they would charge a low interest (1% to 2%).

The rate of interest on the loan must be at least equal to the IRS-approved Applicable Federal Rate (AFR). Each month, the IRS provides various prescribed rates for federal income tax purposes. That rate is currently set at around 3.61% -which, will continue to rise as the fed hikes rates.


Gift Exclusion

There is a gift tax exclusion for up to $14,000 per year. This number changes with inflation. In 2017, you can gift each child or grandchild up to $14,000 per year without being subject to a gift tax. All that interest you should have been charging, as well as any other gifts for the year, made to the same child would have to be in excess of the $14,000 exclusion.


Loans that are really gifts

Some people think they won’t get caught by the IRS, and that they can give their children money for college and just call it a loan.

Members in my community resounding said they would just let the kids borrow the money. No loan agreement. No interest.

The IRS is wise to this.

If you don’t make a loan for college legal and enforceable, the IRS may determine that your “loan” was really a gift and subject the entire amount to gift tax rules.

Avoid all the tax complications by having a written loan agreement. Draft up an agreement yourself or find one online.


Final thoughts

I don’t have a problem with parents lending money for college to their kids. It’s how parents and relatives give their kids the money that’s the problem.

College is big business.

The sooner that message sinks in, the better off you’ll be. And like any big business to consumer relationship, you need to do your homework.

Each year colleges spend thousands of dollars on each student to recruit them. Nothing makes them happier than when family members start gifting money.

Family members don’t consider how the gifted money for college ends up reducing the child’s financial aid eligibility. The college ends up keeping more of their endowment money and it became that much cheaper to recruit your son or daughter.

Only those with a financial need can get financial aid. If Grandma Jo gives your kid $1,000 as a birthday gift for college, the college will claw back $500 of financial aid. There’s less need.

Having a clearly defined financial strategy will help you get your child into the college of your choice for the least amount of money. It will help you compare colleges against each other and choose the one that’s best for your child.

More importantly, it could save a student tens-of-thousands of dollars.

How many kids do you have to send off to college?


Making a difference in families lives

Traditional financial advisors see college planning a funding problem. In their eyes, parents aren’t saving enough. In reality, they don’t understand how the college and student loan system works.

Today parents want and need more from their financial advisor than just simplistic college savings strategies.

College is an extremely important and expensive investment for most families. They want to work with an advisor that understands how the college and student loan system works.

We are that advisor and help our clients put their children into top-tier colleges for the lowest cost possible.

We invite you to join us on this journey. Let us help. We’re a fiduciary.


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