Friday, May 1, 2009

Save For Your Child's Education - Part 3

Tip #130 - Save For Your Child’s Education – Part 3. In part 1 of this series, we discussed why it is important to save for your child's future. And it part 2, we discussed the various ways you can save for college. Today we will discuss the Coverdell Education Savings Account (ESA) in detail. The government allows contributions of up to $2,000 per year into an ESA vehicle. Up until 2001 the limit was only $500 per year. And as of 2010 the limit may revert back to $500. Like IRAs, you can use this vehicle name to save money in savings accounts, CDs, bonds, mutual funds, stocks, etc. While contributions are not tax-deductible, the earnings grow tax free in these accounts as long as you use this money to cover education expenses. You can use this money for primary and secondary school as well college or vocational school. You can also use it for books, school fees, or room and board, as well as tuition.

These reasons make it an attractive choice to use as a savings vehicle for college. In addition, you get to direct where the money is invested. You can take on as much or as little risk as you like. If the account is in the parent’s name, the money won’t be considered the child’s money if he is being considered for financial aid. The last benefit to an ESA account is that the money can be moved to another child in the family if the child it was designated for does not use it.

There are some downsides to Education Savings Accounts. The limit in 2009 is $2000 and may go down to $500 in 2010. Even saving $2000 per year from the day a child is born until he goes to college will not cover the costs of a 4-year school. People above certain income levels are not eligible to contribute to an ESA, although the levels are fairly high (modified adjusted gross income levels below $110,000 for single parents and $220,000 for married couples). The money in an ESA account must be used by the time the child turns 30 or if must be transferred to another child or you will pay taxes and penalties.

In general, if you meet the income requirements, the ESA is an attractive vehicle to start your child’s education fund. If you want to contribute more than $2,000 per year per child, then you will need to find other places to save. But because you have control over where you invest, I think it is the first place you should start your college savings.

In Real Life (IRL) – I mentioned in Part 2 of this series that our children’s college education fund is all in Education Savings Accounts. I did it this way primarily because I like to have control over where my money is invested. I tend to be a conservative investor. And while some people would disagree with putting a child’s education fund in safe investments when college is 10 to 20 years away, I do what I am comfortable with. We have about $18,000 saved for college for our oldest daughter. I have about 25% of that in stock mutual funds and the remaining 75% is in CDs earning between 4-5% interest. Most financial experts would probably recommend that the asset allocation be reversed for someone who is 7 years old – probably 75% stock and 25% in conservative investments. And that is the reason I like the ESA account – because I have control over how to invest the money.

If I were putting away more than $2,000 per year, I would look into a 529 plan, but at this point we are not doing that, so an ESA fits our needs better. If you want to put away just a little bit of money each month or each year, an ESA is a perfect way to start saving for your child’s education. In the next part of this series, we will discuss 529 savings plans in more detail. For other tips on saving money and frugal living, please check out Life As Mom.

*As always, what I write here is my opinion only. Any investments you make are best discussed with a certified financial planner.

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