It’s a heart-wrenching call. Few families are in the fortunate position of being able to fully fund all their retirement options and fully fund a college savings plan for their children or grandchildren. If financial aid, scholarships or the GI Bill are not forthcoming, nearly all of us have to make tradeoffs.
Among the options are Self-Directed IRAs and Self-Directed Coverdell Education Savings Account (ESA). These accounts allow for the purchasing of assets within the account and the profits grow tax-free and/or tax-deferred (depending on their income bracket tax savings can be as high as 40%). That means they can use those additional dollars to get to their savings goals more quickly.
So if you have to choose, what should take priority? We believe a Self-Directed IRA and/or a Self-Directed Solo 401(k) is the answer. Here’s why:
- Your child or grandchild (henceforth, “child”) can borrow money against future earnings to go to college. No one is going to lend you money to retire on – unless it’s against assets such as real estate you’ve already earned.
- Your child may earn scholarships. You don’t have to be an All State-quality football player to get a lucrative scholarship. A wide variety of scholarships are available for students of all kinds:
- Musical (especially in low-brass instruments)
- Ethnic scholarships from a variety of benefactors
- Special scholarships for disadvantaged children
- Scholarships for the children of veterans
- Scholarships for veterans
- Reserve Officer Training Corps (ROTC) scholarships for future leaders of Armed Services
- Local service group scholarships from groups like the Kiwanis and Rotary Club
And many others.
There aren’t too many similar supplemental funding opportunities for your retirement!
- Your child may qualify for need-based financial aid. Now, if you’re extremely wealthy, this may not be in the cards, of course. But for those families toward the fat part of the wealth distribution bell curve, it is a major planning factor.
- Your child may join the Armed Services and therefore qualify for the valuable Post-9/11 GI Bill.
- Your child or grandchild may choose not to go to college at all. It’s not the best thing for everyone.
- You may be able to borrow against a Self-Directed Solo 401(k) if you so choose. If you are a self-employed or closely-held business owner and you want to create your own Self-Directed Traditional 401(k) to allow for this feature, give us a call.
- You can withdraw up to $10,000, penalty-free, from a Self-Directed IRA, if you choose, to help fund qualified education expenses for an immediate family member.
- Student loan debt interest is tax-deductible. Your senior day care, nursing home and long-term care expenses and insurance premiums are generally not.
- Students can qualify for student loan payment deferment or forbearance programs if they run into trouble. There are no similar programs for retirement expenses.
- College degrees are no guarantee of a good job or career. Far from it. A recent survey from the Urban Institute found that as many as 25 percent of college degree holders were working in jobs that did not require a college degree at all.
- No parent wants to be reliant on their adult children for living expenses – even if they got that way by overfunding education at the expense of their own retirement plans.
Exception: Does your child attend private school? Or does he or she have significant educational expenses coming up? For example, boarding school costs, computers/learning technology or tutoring? If your family is going to incur these expenditures anyway, regardless, you may want to explore funding them via a Self-Directed Coverdell Education Savings Account (ESA). This is a special account you can contribute to save in advance for education costs, and expenditures for qualified educational expenses are tax-free and penalty-free. They have an advantage over Section 529 plans in that you can use them for elementary and secondary education expenses and not just college expenses.
There is no tax-deduction available for Self-Directed Coverdell Education Savings Account (ESA) contributions. Essentially, they are taxed similar to Roth IRA accounts, but there is no RMD. You just have to use the money before the child turns 30 (except for special-needs individuals). You have until April 15th, generally, to make contributions for the preceding tax calendar year.
Be sure to mind your contribution limits: $2,000 per beneficiary, and $2,000 per contributor per year.
In essence, if you properly manage the account, this means the first $2,000 of a child’s educational expenses at the elementary, secondary or college level can be tax-free. If you are planning on sending your children to private schools anyway, and you otherwise qualify for a Self-Directed Coverdell Education Savings Account (ESA), it may make sense to prioritize Coverdell contributions you were going to spend anyway over retirement savings vehicles.
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