Thursday, April 30, 2009

Save For Your Child's Education - Part 2

Saving Money Tip #129 - Save For Your Child's Education – Part 2. In the last post, I explained why I think it is important to help save money for your child’s education. In today’s post we will discuss various ways in which to save that money. There are several ways you can put money away for your child*:

--You can put money into any of your accounts or open a new account and basically just call t “college savings.” This can be a bank savings account, CD, bonds, mutual funds, stocks, or pretty much anything. While this is not necessarily a bad plan as you can use the money for anything if your child does not go to college, it does not have any tax incentive to help build college savings faster.

--You can put money away in your child’s name. Again, this can be in any type of account. One advantage to putting money in your child’s name is that children may not be taxed on some of their interest income (I believe it’s up to $600). However, a disadvantage is that if your child is applying for financial aid for school, then any money he has to his name counts against him in the financial aid formula. Another disadvantage is that when the child is old enough to withdraw the money, he can really use that money for anything, even if he doesn’t want to go to college, which may or may not be agreeable to you.

--Roth IRA – While the Roth IRA was developed to be used for retirement savings, there are some features associated with it that make it appealing to use for your child’s college education. I wrote about Roth IRAs here. While you already paid taxes on the money you put into the Roth account, it grows tax-free and you can make withdrawals from the principal at any time for any reason without penalty. Because of this feature some people like to use the Roth IRA for education purposes. I generally do not like the idea because there are other ways the government has given us incentives to save for education. And unless you have your retirement savings fully covered, you should be using the Roth IRA vehicle for your retirement savings. However, if you have been a great saver and by the time your child is ready for college, you see you have money to spare in the Roth IRA account, it’s perfectly legitimate to use some of the contributions for college. And money in your retirement accounts generally won’t count against your child if he is applying for financial aid.

--Coverdell Education Savings Account (ESA) – The government allows contributions of up to $2,000 per year into an ESA vehicle (this limit may be ending in 2010). Like IRAs, you can use this vehicle name to save money in savings accounts, CDs, bonds, mutual funds, stocks, etc. Money grows tax free in these accounts. We will discuss the ESA accounts further in my next post.

--529 Plans – This is named after section 529 of the IRS code and there are two types of 529 pans – a savings plan and prepaid college plan. Most people refer to just the savings plan as a 529, calling the other a prepaid college plan, which is what I will do here.

1. 529 Plans are offered through most states and offer no limits on how much you put in. Money grows tax free at the federal level (and if you open an account in your own state, it may grow tax free at the state level as well). We will discuss the 529 plans further in a future post.
2. Pre-Paid college tuition – Many states offer a plan where you can pay money now and they will guarantee that your child’s college education at a public state university is fully paid for (usually tuition only) when it’s time for your child to enter college. Using this plan, you don’t have to worry how well your investments are doing or how much the costs of public colleges in your state will increase because you lock in the rate when you pay. We will discuss this option in more detail in a future post as well.

In Real Life – Soon after my first child was born late in 2001, we started putting money away for her college education. In 2001 the legal limit on the Coverdell Educations Savings Account was only $500 and if we had our act together between November 2001 when my daughter was born and year-end, we would have contributed even that small amount. But with our first newborn, we didn’t have our act together, so we didn’t start contributing money to her college until 2002. By then the Coverdell ESA had increased its limits to $2,000 and that is what we started contributing each year to her college fund. At this point, our oldest is 7 years old and we have about $18,000 in her college savings accounts.

If we had more funds available to save, we would next put our money into a 529 plan, but at this point we don’t. We figure putting $2,000 away per year will probably cover only one year of college. My daughter does have an account in her name that we add money to when she gets birthday gifts or other earnings, but those savings are relatively small. Our Roth IRA is being fully funded for our retirement, so that is not going towards college. I will discuss in a future post our plans for saving the rest of the money needed to fully fund college for our children.

*What I write about here is my understanding of different plans, but I am not an expert on financial matters. How I invest is simply that. It is not necessarily advice for how you should invest. Talking to a qualified financial planner is best.


Anonymous said...

I do agree with your opinion. We have to save for our children. Now everything is very expensive so future planning is needed everywhere like health, education etc.
Nice blog & posts are also informative. Keep it up. All the best from my end.

marry said...

Blogs are so informative where we get lots of information on any topic. Nice job keep it up!!

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Thomas Watson said...

Thanks for the tips. It really makes sense to save for parents (and, perhaps, grandparents or other family members) to start saving for a child’s education well in advance, if possible, because he cost of a college tuition continuing to escalate.