Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. It's graduation season, and many people might think a check to the new grad is the best gift. Christine Benz, our director of personal finance, thinks that there's some more nuance there and some other choices that you have.
Christine, thanks for joining me.
Christine Benz: Jeremy, great to be here.
Glaser: You think that when thinking about gift giving to new grads, you really do have to consider their life stage and that cash may not always be the best choice?
Benz: That's right. For people exiting high school, oftentimes college is on their radar, so some sort of dedicated college savings vehicle might make sense. If it's someone who is exiting college, maybe they have higher education or further education on their radar, maybe additional savings for that educational expense makes sense. For people who are exiting college and beginning new jobs, you may have some other investment types that you want to help contribute to on their behalf.
Glaser: Looking at high school grads, or someone who has grad school on their future, are 529s really the best vehicle?
Benz: Well, certainly, when it comes to the tax benefits, 529s are hard to beat. As long as the money stays within the confines of the 529 plan, assets can be invested and grow without any tax burden. Then when you pull the money out for college expenses, for qualified college expenses, those withdrawals will also be tax-free. Another key advantage is that if you contribute to your home state's 529 plan or whatever plan you contribute to offers tax deductions or credits, that also burnishes the appeal of 529 plans from a tax standpoint.
Glaser: One downside though can be how it impacts your financial aid?
Benz: That's right. It does depend mainly on your relationship to the student. If you are a parent, the 529 assets tend not to be particularly punitive from the standpoint of that FAFSA form, that financial aid form. But if you are a nonparent, say, you are a grandparent or an uncle who wants to contribute to educational expenses, those assets will tend to affect the child's financial aid eligibility if they are spent prior to the child's final year of college. That's one reason why college funding experts say, if you are a nonparent, advise the parents to hang on to those assets until that last year of school, so it won't affect financial aid eligibility.
Glaser: Writing a check or giving cash also is going to impact financial aid too?
Benz: Well, it could. Large cash gifts to a student will potentially affect their financial aid eligibility; so will saving for the student within the confines of a UGMA/UTMA account, because those assets are technically the property of the child. That tends to look the worst from the standpoint of the financial aid applications. The other thing to know about the UGMA/UTMA accounts is that those assets become the property of the child when he or she reaches the age of majority. The child does not bound to use those assets for college funding. If that's your goal, you may want to get the money inside some sort of college savings wrapper.
Glaser: Let's talk about investing in these 529 plans. Sometimes the time horizon is quite short. For a high school student, it could just be a couple of years. What's the right asset mix that's going to make sense?
Benz: It's a really good question. Certainly, if you have a time horizon of, say, shorter than five years, you should not be in stocks with that component of the 529 plan. You'd want to focus on high-quality bonds, ideally short-term bonds, perhaps even cash investments for very near-term expenditures. Some 529 plans have stable-value funds. Those can be a nice option that offer you a little bit higher yield than cash, perhaps a little bit more risk, but not much more so. That's another vehicle type to investigate.
Glaser: Turning to the grad who doesn't have school in their future again, what are some of the options there that could get them off on the right foot?
Benz: There are a couple of things to think about. One is, if the student has some sort of student loan that he or she is exiting college with, perhaps you can lend a helping hand in terms of paying down that debt. The typical student exits college with about $30,000 in college expenses or in college loans. Many students have much more than that. If you can help burn through some of that debt, I think that that's a really gracious, terrific thing to do.
Another idea is, if you have someone in your life who is just exiting college, maybe getting an apartment, getting that first lob, maybe you can just give a baseline of cash and counsel about the virtue of having that emerging cushion. Say, this is not money that I intend for you to use to take great trips or buy a car. This is money that you are going to use to hold as an emergency fund to help defray any unanticipated costs. You can do a little bit educating along the way.
Finally, for young people who are exiting college and who have landed jobs, one other idea is to consider contributing to a Roth IRA on his or her behalf. The big advantage is that that young person can take advantage of his or her very long runway to grow those assets for retirement. Of course, there are really valuable tax benefits that accompany a Roth IRA. The other thing I like about the Roth IRA as kind of starter savings vehicles is that it can multitask for emergency fund needs and for long-term retirement funding. If you pull your contributions out of a Roth IRA, there will be no taxes or penalties, which makes it a nice, kind of, retirement savings vehicles with training wheels for people who are trying serve multiple goals.
Glaser: The question I know you get a lot is about the gift tax and people being worried about the gift tax. You think a lot of these worries are overblown?
Benz: I do. If you contribute or if you give more than $15,000 to a single individual in a single year, so in 2018, you will have to file a form to accompany your tax return. But unless your total lifetime gifts combined with your estate after your death exceed $11 million, you will not be subject to actual gift tax. You won't have to pay extra taxes for having been generous during your lifetime. I do think that sometimes people hear about that gift tax form and think that it necessarily entails paying extra tax; in most cases, it doesn't.
Glaser: Christine, thanks for your gift giving tips today.
Benz: Thank you, Jeremy.
Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.