Many parents and grandparents set up college funds for their children or grandkids. Given the cost of higher education today, starting a college fund early could help ensure they can earn a degree without the burden of overwhelming student loan debt.
But given today’s sluggish entry-level job market, funding a college education may no longer be enough to help your kids or grandkids be financially stable in young adulthood. In addition to education, you may want to create a “launch fund” — money your heirs can use to supplement their post-college paychecks or reserve for a down payment on a home.
Here’s how a couple of experts suggest approaching your launch fund, and how to balance it with your own financial needs.
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Your financial security has to come first
It’s noble to want to set your kids or grandchildren up for financial success. But Tyler End, CFP, CEO, and co-founder of Retirable, says it’s important to prioritize your own financial needs and only give what you can truly afford.
“There can be a strong emotional pull to be looked at as the provider, but it is important to pay yourself first,” he says. “There are no loans for retirement income like there are with college. It doesn’t help to stretch yourself and ultimately become a worry for your heirs.”
Beth Stenz, CFP and financial adviser at Edward Jones, agrees.
“I would start with one important rule — secure your own retirement before funding the next generation,” she says. “A young adult has decades of earning potential ahead of them.”
Before earmarking significant assets for younger heirs, Stenz says, make sure your retirement savings are sufficient or on track. Also make sure you have a solid emergency fund and a plan for what she calls “potentially significant health care or long-term care costs.”
Decide how much flexibility you want
Accounts like 529 plans offer tax benefits, but they’re meant for education expenses. If you end up with excess funds, you have options, but avoiding tax penalties requires strategic planning.
If you’re going to set up a launch fund, Stenz says, you may want to use different “buckets” or accounts that address different goals.
“A launch fund is ultimately about flexibility,” she says. “The money may be used to supplement income during a difficult job market, fund additional education or training, help with a relocation opportunity, support the early stages of a business venture, or assist with other important milestones in young adulthood.”
To that end, Stenz recommends thinking about how much money you want to earmark for education versus other young-adult expenses. You’ll also need to decide how much control you want to retain over the money, and for how long.
Account options to look at
Once you’ve narrowed down your specific goals, Stenz says, you can look at different account options.
Taxable brokerage accounts
“A grandparent-owned taxable brokerage account can be particularly attractive for a launch fund because of its flexibility,” Stenz says. “The grandparent retains ownership and control, there are no education-only spending requirements, and the money can ultimately be used where it is most valuable.”
If you’re going to use a taxable account, your investment allocation should reflect when you may need the money, Stenz says.
“A fund for a 2-year-old can generally accept substantially more market volatility than money intended for an 18-year-old,” she explains.
Stenz says a 529 plan is still an excellent option when creating a launch fund.
“Earnings receive favorable federal tax treatment when distributions are used for qualified expenses, and a grandparent can establish the account with the grandchild as beneficiary. I particularly like that the account owner retains control rather than simply handing the assets to the child,” she says.
End says that funding college and young adulthood can be a tricky balancing act.
“The cost of education can vary greatly or be non-existent depending on the path taken,” he says. “The best course of action is to decide what is most aligned with your values and give the gift that will make the biggest impact. For example, if education is important, prioritize making that accessible.”
Thanks to recent rule changes, 529 plans allow the beneficiary to roll over up to $35,000 into a Roth IRA over their lifetime. That gives you the option to help a child or grandchild’s college education, save for graduate school and start a retirement nest egg if they don’t need all the money while earning degrees.
A number of parents and grandparents have “superfunded” 529 plans to support their heirs and get a nice tax break. As a result, some young adults have substantial 529 accounts that, even after a $35,000 rollover, would still leave them with more than they could spend on education. A Senate proposal would allow unlimited Roth IRA rollovers from unused 529 funds, but its fate is uncertain.
Custodial accounts
Custodial accounts are similar to brokerage accounts, only with a brokerage account, you retain control perpetually. With a custodial account, ownership eventually transfers to a child or grandchild at a certain age.
“Typically you structure them under Uniform Transfers to Minors Act or Uniform Gifts to Minors Act accounts where the ownership transfers at a set age, giving the beneficiary full control of the funds,” End explains.
If you go this route, keep in mind that because a custodial account is owned by your child or grandchild, it could affect their ability to qualify for college financial aid. If you’re planning to fund their education entirely, this may not be an issue.
Trump Accounts
Trump Accounts, says Stenz, add another potential tool to the mix. You can contribute up to $5,000 per year, per child, to one of these accounts, and the money grows tax-deferred. Funds are locked until the beneficiary turns 18, when the account converts to a traditional IRA.
A Trump Account won’t help your child or grandchild cover the rent as a young adult or buy a new car. But it could give them a vital jumpstart in building retirement savings.
Share your plans so no one’s in the dark
Whether you’re saving to help a child or grandchild tackle young adulthood, End says it’s important to share your thoughts and get input from the loved ones you’re trying to help.
“Don’t hesitate to open communication with your family,” he says. “You might have an idea of how to make the biggest impact, but opening the dialogue might help you learn what will make the biggest difference.”
You may, for example, be inclined to prioritize 529 plan contributions. But if your teenage grandchild already knows they don’t want to go to college, your money might be better off in another account. Having open conversations could help you achieve your ultimate goal of making life easier for a child or grandchild you care deeply about.