Q.
My parents are in a position to really help me financially in medical school. What should be considered in deciding our best moves?
A.
I have written before about how multiple generations working together financially can be highly advantageous compared to a family where every generation attempts to optimize their own financial outcome. This post will be specific to this one issue.
Best For You Or Best For The Entire Family?
The first consideration when deciding the best way to proceed is to decide if you are trying to optimize the outcome just for the student, or if you wish to optimize the total financial benefit and expense to the family. This is primarily a value judgment, but if you decide the goal is to optimize the benefit to you, then you simply try to get as much as you can from your parents at the best possible terms and then go with it. It’s not particularly complicated- you simply take what they are willing to give. They get to feel good about their contribution and you’ve maximized your outcome. However, where it really becomes complicated is when the goal is to optimize the overall outcome for the entire family.
Dependent Status
For many parents, being able to claim their student as their dependent can be fairly beneficial. In 2015, the personal exemption is $4K per dependent. If you’re willing to be your parent’s dependent, and they’re in a 40% marginal tax bracket, then it is worth $1600 a year to them for you to be a dependent. What’s the downside? Well, your standard deduction drops from $6200 to $1000 (technically the greater of $1000 or $350 + your earned income up to $6200.) Plus you don’t get to claim yourself as an exemption. This could increase your taxes if you have significant earned income. If you don’t have significant earned income, then great, let your parents claim you if they possibly can. As a general rule, the taxpayer with the higher marginal tax rate should claim the dependent, assuming their income is not so high that the exemption is phased out. (AGI of $432K+ for MFJ.) [Update: If the parents are paying under AMT, their income doesn’t even have to be that high.]
There are rules for claiming dependents, of course. Your dependent must be a US Citizen, US National, US Resident, or a resident of Mexico or Canada. A dependent also cannot be claimed on anyone else’s taxes, including their own. You also cannot claim someone who filed a joint return with someone else. In addition to those rules, your dependent must fit into one of two categories.
The first category is a qualifying child. This person must pass five tests.
- Relationship test- Son, daughter, step-child, grandchild, brother, sister, niece, nephew, adopted child, foster child etc.
- Age test- Under 19 or under 24 if a full-time student (and younger than you and your spouse), or permanently disabled. Unfortunately, this test alone will rule out many medical students, at least in their last couple of years.
- Residency test- Must live with you more than half the year. Education and military service are valid excuses however.
- Support test- The child cannot have provided more than half of his support for the year.
- Joint return test- The child cannot have filed a joint return with anyone (except to get withheld taxes back.)
The second category is a qualifying relative. This person must pass four tests.
- Not be a qualifying child (see above)
- Related to you (in pretty much anyway) or a member of your household for the entire year
- Gross income test- Make less than $3,950
- Support test- You provided more than half his support (slightly different from the child rule). If no one provided more than half his support, however, it can be mutually agreed upon as to who gets the exemption.
Educational Tax Benefits
There are tax benefits for the person who actually pays for education. There are two tax credits, the American Opportunity Credit (basically undergrads only) and the Lifetime Learning Credit (only available to people with a MAGI of < $62K [$124K married]). The LLC is 20% of up to $10K spent on qualified educational expenses. Many parents capable of providing significant help to their medical student children aren’t going to be able to use either of these credits.
Beyond the credits, you are also allowed to deduct up to $4K in tuition and fees for your child. However, this requires an income (MAGI) of < $80K ($160K married) in order to be claimed. Again, well-to-do parents are going to be excluded.
The student loan interest deduction of up to $2500 of interest paid may also be useful, but high-income parents are again excluded by the income limit of $75K ($150K married.)
The author rappelling off a bag of water near Lake Powell
Gifting Laws
In a situation like this is it also useful to be aware of the gifting laws. Essentially, any person can give $14K a year to any other person without having to file any kind of paperwork or pay any kind of taxes. The gift tax actually isn’t a tax most of the time. On a federal level, if you give more than $14K a year, it simply comes out of your estate tax exemption, which at over $5 Million ($10 Million married and indexed to inflation), is probably enough and to spare for all estate and gift tax considerations for most docs. But just in case, it might be wise to preserve it. Also, be sure to look into whether your estate has an estate tax/gift tax with a much lower exemption level. You can preserve the exemption by only giving $14K a year. But keep in mind that is $14K from each person to each other person. So you can give your child $14K a year, your spouse can give your daughter $14K a year, you can give your inlaw $14K a year, and your spouse can give your inlaw $14K a year. $56K a year all without using up a bit of that exemption!
In addition to the $14K a year, the parents can pay tuition directly to the school without using up that exemption.
Once you hit $14K a year, you’re required to file this form with the IRS. But if you’re like most, you can just work the laws to avoid having to file it.
Loan Laws
The parents may prefer not to give the money to the child, but rather to loan it. This can be done informally, especially if under the gift tax limit- “I’ll ‘loan’ you $14K a year, and you can pay me back when you’re an attending,” but if you want to formalize it, the IRS technically requires you to charge a market rate for interest (currently about 2.7% for long-term loans.) If you do not, the “forgiven” interest is considered a gift and is subject to gift taxes (again, $14K a year will cover a lot of forgiven interest.) There are special rules if the loan is less than $10K and if it is between $10K and $100K, so be sure to read those if you’re going to do this.
Mortgage or Margin Loans
Sometimes parents don’t have the money, but have access to credit at rates and terms that are much better than what is available to the student, especially a grad student relying on private lenders. As a general rule, I think if someone is going to borrow for school, that it ought to be the student. Prior to borrowing money, the parents should be aware of several things:
- There is no PAYE/IBR, or PSLF for parental loans. While getting a loan at 4% instead of 6% seems great, it could end up costing hundreds of thousands more if those 6% loans could have been forgiven.
- If the student can’t or doesn’t finish school, doesn’t match, and/or can’t pay back the loans, the parent is still on the hook. The unmatched rate is 5% for US MD students in the MD match, 20% for US DO students in the MD match, and 50% for US citizen FMGs in the MD match. There’s real risk there.
- If the student dies, the parent will still owe the money. This can be worked around by purchasing inexpensive term life insurance on the student’s life, of course. The interest savings will generally more than cover the insurance costs.
However, a deductible HELOC or mortgage at 3%, or even a low-cost margin loan, is obviously far better than an unsubsidized, undeductible 6 or 8% loan.
Outside the Box
There are other, outside the box, ways to assist a child. We had a post a few months back about a medical student who used 0% credit cards to dramatically reduce the interest costs of her student loans while in medical school. Parents, especially well-to-do parents, often have access to far more credit than a medical student and can use similar techniques.
If the student has some income, the parents can do the “mommy match” and help the student max out Roth IRAs or do Roth conversions. For example, if the student earns $5K in the summer, but needs that $5K to pay expenses, the parent can give the student $5K for expenses while the student puts her $5K into a Roth IRA, never to be taxed again.
At some universities, children of employees receive dramatic tuition reductions, often 50% or more. When it comes to medical, dental, or law school tuition, this may be the equivalent of a large raise, so serious consider should be given to working for the school your child attends if this is an option.
Parents are often savvier financially than medical students. Of course, that’s not saying much since medical students may be the financially dumbest people on the planet. At any rate, a little financial advice from the parent may go a long way. Here are some examples:
- “Don’t take out your loan money until you actually need it.”
- “Use a high-interest savings or checking account.”
- “Don’t use that loan money to buy a new car.”
- “You did apply for the food stamps/Medicaid etc that you’re eligible for, right?”
- “If you love Pediatrics and Orthopedics equally, choose orthopedics.”
- “Get a roommate.”
- “Quit drinking expensive beer.”
In summary, there are many ways that parents COULD help out a medical student. Whether they are able to do so or should do so are separate questions. But there is no doubt that when multiple generations work together toward common goals, real synergy can happen.
What do you think? Did your parents help you out financially in medical school? How did they do so? Would you help your child get through professional or grad school? How do you plan to do so? Comment below!
If one has money and want to give it away, you can give 5 years worth of gift money (i.e 14K x5) without any tax consequences in a 529 plan in a year.
In spite of our high income, we have been lucky to get more money to put away for kids education from our Grand parent.
My grandmother immigrated here at age 16 from Europe with one suitcase, which I still have to ground me. It was smaller than a carry on bag. She didn’t want to work in a factory like the rest of her family. She became a nanny for a physician. Now two generations later, I am the physician who has hired nannies, actually au pairs. I strongly believe in the idea of familial wealth. Her choices gave us opportunities which we took full advantage of. We will use our finances to make the road easier for our kids as they are making wise choices guided by us. My son starts medical school this fall. He stayed at an in state university for college on full scholarship. He worked and saved along the way. We barely touched his 529 money. He will stay at an in state medical school at half the tuition of fancier named private schools. He should make it to M4 year before having to discuss if a loan is necessary. He should not have to start 150K in the hole like we did 25 years ago.
Beautiful thoughts Dr Mom. I have been looking for you on the forum. Do you plan to post?
Hope to eventually get there. Life’s busy lately. One of my New Year’s resolutions was to enjoy putting finance on the back burner again a la Coffeehouse Investor.
ok just checking
My parents were the same way. Immigrated from Europe in their early 20s, got jobs, and helped pay for college and medical school. I went to a private UG, however, it offered many scholarships which came out to the same price as our instate school. I then choose to go to the cheapest medical school I got into and was able to secure the residency of my choice (without going to the well known “top 20” schools, ect).
I have a small fraction of the loans that my coresidents have and for that I am grateful. My parents believed in allowing us to have the best opportunities in life while incurring as little debt as possible, so that we don’t have to start in the hole.
I’ll do the same for my children.
I find when I think about finance in a time frame longer than just my life span that I make better decisions and keep a lot of the market noise, like the recent correction, in perspective. None of my grandparents had even the equivalent of a 6th grade education, but two generations later we are all college educated and many are professionally trained.
I too went to private undergrad on scholarship and private med school on a full tuition scholarship. The private school that my husband and I attended has changed so much that we were very disappointed. My kids were not interested in attending it despite getting accepted. Our public university offered them better major choices and opportunities. Our public university offers merit scholarships independent of need based solely on grades and ACT/SAT scores. So, parental finances do not come into play. We never even bothered filling out a FAFSA. The kids were rewarded for their hard work and not penalized by our family finances.
When I was able to be claimed as a dependent for taxes, my parents and I would each calculate taxes if I was claimed or not. Usually they would get a higher increase in money back if I was a dependent than the increase I would get if I was not a dependent. We had a system where they would file with me as a dependent and then give me the amount that I would have additionally gotten back if I wasn’t a dependent. E.g. if they would get an additional $500 back with me as a dependent and I would get an additional $100 back without me being a dependent, they would give me $100 (keeping the other $400). It was a win-win.
We are planning a move so our children would have access to cheaper in-state higher education. Otherwise we would end up spending all we have saved for their education on just one of them.
Food Stamps! DUH! So mad at myself right now.
I did however participate in a study that not only paid me but provided all of my meals for 2 months!
With my daughter’s fellowship money starting last summer we figured we no longer provided half her support. However she pointed out that the car, nominally hers as a b’day gift the prior year, hadn’t actually been titled in her name until ’15. And there was also the sizable graduation present (a vanguard MF start). That tips us over 50% support for one last year. (grad school engineering not med school- don’t we wish they got fellowships for that?!?)
I come from a long family history of each family optimizing their own financial situation and passing the drive and need for education and hard-work, while expecting you to mostly make it on your own. One grandpa was an engineer, did enough to support himself. Other grandpa grew up in poverty and was a self-made millionaire as a general contractor, always lecturing about not giving handouts because he made it on his own and so you need to do it on your own too. My parents have helped with small interest-free loans and at times small financial gifts in times of need but nothing like paying for my education or a car. Finances have deterred several of my siblings from getting a college education. The idea of multiple generations helping each-other for the well-being of the whole family is somewhat foreign to me.
I hope to change that for my children/grandchildren and hope to be able to help my nephews/nieces as well. WCI’s frequent discussions about 529’s, Roth IRA’s for your kids, and even the 20’s funds have given me the burning desire to put my kids in a better position than I’m in (250K of student loans and still 1 yr of med school left). I plan to also help my parents in their old age if my dad’s retirement and pension isn’t enough to carry them.
Fascinating how you can read financial blogs constantly, always read WCI, never learn anything new 99.9 % of the time and then randomly come across a sentence that can dramatically impact your financial life.
I had always thought that the gift-er was taxed at gifts above the annual limit, not that a gift above the annual limit limits the life time estate tax deduction. My parents have been gifting me the annual limit to avoid paying state estate taxes.
Great to know they can just cut me a check for <10M and be done with it.
I'm going to start shopping for Ferraris (Just kidding), but this is seriously useful information for me. Thanks.
Enjoy the Ferrari.
State estate taxes are different than the feds 😉
I recently came across WCI web and immensely enjoyed it.
This particular article has been an interest to me. Over the years, I have develop quite a respect to US graduates as I come to know how much you guys are in debt. most of you pull out of that deep hole and with in 20-30 years build an amazing comfortable retirement saving. I am a foreign graduate and do not see our perspective discussed here and decided to add my thought. We usually have very little debt if at all: nowhere near to you guys. On the other hand for most we are the only bright spot of a big family and have to support immediate and extended family back home. More than all this financial burden though, we seriously have a big knowledge gap when it comes to money, retirement and saving. Most of my friends I know are working for what it seems for life. most will drop dead at work it seems as their retirement balance is very small. I wish there is a way to teach young foreign graduate physicians on the crucial meaning of “time” when it comes to compound interest saving.
Lucky for me, though I came with a small suitcase at hand with no money in pocket, a seemingly inconsequential talk on retirement planing talk that I listened when i was a first year resident changed my life for the better. Though I am in one of the low paying IM speciality field and in a University program with the past 12 year of work, as a single income earner in our family, following the simple but timeless advises of maximizing retirement saving, I am marching towards the prized “one million net worth club”. This will definitely happen few months from now! Now I am learning how to transfer wealth to kids at a maximum protection
Thank you for all the advices you provide us!!
Well done and you’re welcome. You’re right that the learning curve is a little steeper for a foreign grad, but they should be able to make up for it with a smaller debt burden.
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My parents also wanted to help me with paying for medical school, but I refused their help. I studied at medical school and worked part-time at https://edubirdie.com/nursing-papers-for-sale to pay my student loan. I have been a fan of Dave Ramsey for a long time and therefore clearly understood that it is worth graduating from a university without loans or at least partially paying it out before graduation. But I did not want to burden my parents in any way.