Balancing Educational Debt Repayment with Financial Planning – Part 2

In the first part of this two-part series, we talked about how recent college graduates can reduce their student debt or pay it off faster. Now, let’s discuss how parents and grandparents can—and whether they should—help with that debt repayment.

The urge to help grown children or grandchildren repay often-crippling student loan debt is understandable. You want to ease your children’s entry into adult life, to enable them to enjoy life rather than wake up each day in dread of the debt they might need decades to pay off. But you should also consider whether paying all or part of your children’s debt is best for them—and for you.

Paying off your children’s debt may make them a little too comfortable by inadvertently teaching the wrong lesson: that someone else will always be there to cover their responsibilities. You could be impeding your child’s growth in learning how to manage money, including how to defer short-term gratification for long-term gain.

It is also important to consider what paying down or paying off your child’s student debt will mean for your own retirement. Where will the money for this gift to your child come from? Is it money you’re now using to pay down your mortgage debt so you can retire mortgage-free? Is it money you would have put in a retirement account to reach a carefully calculated goal?

If you’re paying for this gift by reducing your IRA payments, you’re missing out on the full power of compound interest. If you’re reducing payments to your 401(k), that’s even worse, because it denies you the “free money” that is your employer’s contribution to the account. The result could be that your adult child is more likely to need to support you in your retirement. Before you make any decisions, consult your financial professional to understand the pros and cons so you can maximize the gain to your child and minimize the pain to yourself.

If you decide to help a child with debt repayment, here are tips and options to keep in mind:

1. Make sure the money you pay actually goes toward paying down debt, not penalties. If your child has a private loan or loans, faster repayment could incur penalties. You’ll want to work out a plan to avoid them. Similarly, the amount you gift your child for loan repayment could incur a federal gift tax, with Uncle Sam pocketing part of the money you intend for your child. Check with your financial professional.
2. Does your child have other options that can speed up repayment? For example, you might help your child reduce student loan debt by suggesting an income-based repayment plan. These plans cap student loan payments based on a percentage of their discretionary income and they may be eligible to receive complete loan forgiveness after 20-25 years depending on the plan.¹ Consolidation of federal loans to a single, lower rate, or refinancing a high-rate loan to a lower rate, are other possibilities.
3. Can you make a more meaningful gift? If your child also has credit card debt or other loans with higher interest rates, focus on making contributions to lower these debts, while urging your child to continue to make minimum repayments on student debt. Or, instead of paying down low-rate student debt, it might be more helpful for you to contribute to your child’s retirement account, emergency fund, home down payment, or other targets.
4. Make your child your partner, not your beneficiary, in loan repayment. Rather than simply pay down your child’s student debt, go in on a partnership with your child. You can match your child’s monthly minimum payment with a similar payment of your own, greatly reducing the time and total amount needed to repay the loan. Or, agree to make the following month’s payment for every month your child pays the minimum on time. This provides another incentive for your child to meet his or her contractual and legal obligations, as well as to build a credit rating that will reduce future borrowing costs.
5. Non-financial ways to help your child. You can help your child pay down student loan debt without actually contributing to the repayment. For example, you can allow a child to live at home for a year or two after graduation with the understanding that he or she will pay down student debt with the money that would otherwise go to rent payments.

Helping your child pay down student loan debt doesn’t have to come at the expense of your own retirement—if you do it right.