These gift options can lower college debt and teach money skills to young adults

Instilling sound financial knowledge in children can change the course of their lives.

With many families living paycheck to paycheck and debt at record-level highs, it’s more important than ever for kids to learn good financial planning habits. As the holidays quickly approach, some will consider gifts this year that teach children to manage money just like wise investors.

Some of the options available can help build a college fund for children. As of 2019, the average student loan balance is $35,359, with monthly payments in the hundreds of dollars. And many borrowers are committed to a repayment plan decades long. A debt burden that high can crimp the financial future for many.

Grandparents, parents, relatives and friends have the option to provide gifts such as bonds, stocks, exchange traded funds and indexed universal life insurance that could prepare young people for a brighter future.

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Quite often an adults’ eyelids tend to droop when it comes to lectures about finances. We can’t expect children to endure long discussions about companies that are abstractions to them. Instead, some may consider investments kids can relate to like companies that make their favorite toys, foods, clothing or entertainment.

Children understand these products, maybe even more than you, and could benefit from the excitement of watching their investments in them multiply. Kids look up to their favorite characters and get excited at hearing the name of their favorite brands. Once you identify their favorite character, video game, clothing brand, etc., it will become easier for you to narrow down your stock options.

While stocks have the potential to produce great returns over time, investors are encouraged to guard against the possibility of a bear market. Many people might consider adding zero-coupon bonds or indexed universal life insurance to their education-funding portfolio.

Most bonds distribute interest every six months in payments known as coupons. In contrast, zero-coupon bonds distribute no coupon payments. Instead, all the interest is paid upon maturity. This makes them an appealing investment for some because the bondholder knows exactly how much the bond is worth at maturity.

To use zero-coupon bonds in a college fund, you have the option to buy a zero-coupon bond (at issuance) that matures when the grandchild plans to enter college.

If you hold a zero-coupon bond until maturity, just how much can you make? It depends on the bond’s yield. The imputed interest on the bond compounds on a semiannual basis. The higher the yield, the deeper the discount and the higher the profit.

For example, a $20,000 zero-coupon bond with a 5.5% yield and a 20-year term would sell for just $6,757 when issued. At the end of the term, the investor has $20,000 for college expenses.

Zero-coupon bondholders must pay taxes each year on the yield, even though they receive no income. To prevent this, some people will hold the bonds in a tax-deferred account or may buy tax-free municipal zero-coupons or tax-exempt corporate bonds.

Indexed universal life policies are considered a hybrid of protection and investment for many people. These policies build cash value as the premium payments are made. Like a savings account, IUL policies pay regular interest on the cash value; however, the interest rate is often much higher.

Insurance companies pay interest according to the rise in an underlying index, such as the S&P 500. At worst, should the index be flat or fall, no interest is paid, yet the principal remains safe.

IUL policies are written so that the cash value often can be used to cover the premiums. Payments can be stopped at any time the cash value is sufficient to cover the cost of insurance. When the child becomes an adult, ownership of the policy can be transferred to them. The cash value can then be used as a tax-free source of education funding.

Alternatively, if it turns out the child won’t need the money for financing an education, the gifted money can become the source of a down payment on a home, for example.