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HOW TO SAVE FOR MY CHILD? READER QUESTION

By in Asset Allocation, Automatic Saving, Bond, Mutual Funds, Reader Question, Saving | 2 comments

What are the Best Ways to Save for My Kid?

A friend of mine recently asked where and how he should save for his 8 year old child. This got me thinking about a colossal mistake we made when saving for Jr. Carina.

We thought we were so smart when Jr. was born. We set up a trust and contributed regularly. When College 529 plans came out, we contributed. Our thinking was that college costs would be covered with these funds. What we didn’t think about was that she would not qualify for much financial aid with Jr.’s (relatively) large net worth and that she would be expected to pay far more of her college expenses than her cohort without money in their name.

Save Smart for Your Child

Save Smart for Your Child

Do Not Make This Mistake When Saving for College

2006 arrives and I begin completing the fat FASF student financial aid form. What I found out was that my  saving for Jr.s college in a trust in her name was a huge mistake. These wise saving and investing actions many years ago hurt her chances for financial aid. Here’s the problem, when applying for student financial aid the students’ assets are weighted much heavier than those of the parents. For example, according to Robert Helgeson, Director of Financial Aid for Valparasio University (as quoted in Bankrate.com, “3 Ways to Save for Your Child’s Future,” by Christina Couch).

“In the federal formula that determines how much financial aid a student receives, there are asset protections for money in a parent’s name that are not there for money in a student’s name. If a parent has $100,000 in assets, the government is going to expect them to contribute $6,000 of it to education. If a student has $100,000 in assets, the government will expect $20,000.”

Students won’t lose any financial aid if they have up to $3,000 in a bank account in their name.

How to Save for College

A 529 Plan is an education savings plan named after Section 529 of the Internal Revenue code which created these plans in 1996. These plans are created in most states and can be funded by anyone to be used for educational expenses. They help families amass funds to pay for education, grow tax free, and can be withdrawn federally tax free as well when used for qualified educational expenses. State tax benefits vary depending upon your state.Regardless of your state of residence, you can create a 529 account in any state.

Are you wondering whether contributing to a 529 plan will hurt Jr.’s eligibility for financial aid? Here’s the great part, the donor controls the account and the named beneficiary (prospective student) can’t get their hands on the money. I recommend enrolling directly in a 529 Plan although you can also go through a financial advisor.

What’s the catch?

Here’s the one problem with a 529 plan. If your child does not go to college and you want to withdraw the funds, there is a 10 percent penalty on the earnings from the account (not on your original contributions) and taxes are assessed as well. But, if one child doesn’t attend college, it’s easy enough to change the account beneficiary to another child, relative, or even yourself if you go back to school. Savingforcollege.com is an awesome website to explore 529 plans.

I Bonds are one of the Greatest Gifts of the U.S. Government

I’ve written about US Government I Bonds (inflation protected) many times. They are close to the perfect safe investment for saving. These government bonds are better than CDs or bank savings accounts because the interest payment is adjusted every 6 months to reflect changes in inflation. Thus, if inflation increases, so does the interest payment. There’s also a second fixed interest payment determined at the bond’s issue.

These bonds are ideal savings instrument for children and here’s why:  

  • Return certain to keep up with inflation.
  • State and local income tax free.
  • Can purchase in denominations from $25 to $10,000.
  • They earn interest for up to 30 years.
  • You can cash them in after one year. (If you cash them in from one to five years after purchsase you lose the last three months of interest)
  • Easy to purchase through the Treasury Direct.com website
  • Perfect for paying educational expenses. If bonds are redeemed and used to pay for qualified educational expenses (in the same year the bonds are redeemed), the interest is tax free.
  • The adult can buy the bonds in their own name and experience the tax benefit while paying Jr.’s college expenses. Since they are held in the adults name, their value won’t be counted against the child in the financial aid calculations.
  • If your child doesn’t go to college, you can continue to hold the I bonds while they collect interest or you can transfer them to the child. (Be advised that this may be a taxable event for the original owner).

Other Savings Options for My Child

If you think your child has any chance of attending college, I would not open a brokerage or other account in their name due to the potential hit on qualifying for future financial aid.

Consider opening an investment brokerage account in your name or joint with your spouse. If all or part of this account is designated for your child but you don’t expect to give Jr the funds for a decade or two, invest in a diversified portfolio of index mutual funds. The easiest strategy is to put the funds in a diversified all world index fund such as Vanguard Investment’s Total World Stock ETF (VT). This fund invests in stocks from developed and emerging markets from around the world. This one stop shopping fund covers more than 98 percent of the global investable market capitalization. It includes the U.S. market as well. Since it is passively managed and follows the FTSE Global All Cap Index, the expenses are quite low.

A couple of caveats regarding stock investing. Stocks are volatile by nature and tend to go up and down in value much more extensively than cash, I Bonds, and fixed investments. At this point in 2013, we have seen several years of market increases and so it is likely that there will be some stock market price declines in the next few years. This stock market volatility recommends that you never put any monies in the stock market which you need within the next 5 to 8 years.

Finally, if stock market volatility unnerves you, consider putting a portion of your funds in I bonds and a portion in stocks. That will temper the volatility of the portfolio.

Have you started investing for your child? What investments and accounts are you using?

image credits; google images_flickr.com

 

 

 

    2 Comments

  1. I am so glad you talked about i-bonds and their advantages not only for regular savings, but even more so for college. We max our i-bonds every year, so even with the $10k / SSN, we have quite a bit there.

    My parents gave money to our son for college when he was born. They put it into a UGMA (Uniform Gift to Minors Account). When the low cost 529 in Utah became available, I moved the funds there, but they had to stay in our son’s name. Oh well, beggars can’t look a gift horse in the mouth, or something like that. We also have a 529 we are still adding to in my wife’s name with son as beneficiary.

    Don’t forget that when/if your child starts earning money in a real summer job, a Roth IRA may be opened in their name. A Roth will not count in FAFSA calcs, and the Roth can become a 3rd source of funds for college. (If the child does not go to college, having a head-start on Roth IRA savings will be a good thing.) We plan to pay into his Roth 1:1 for every dollar he earns. There is no earnings penalty if the Roth IRA is used for the same sort of qualifying higher education expenses as a 529.

    Bryce

    August 13, 2013

  2. Hi Bryce, Thanks so much for adding the information about a Roth. Not counting towards the child’s assets for financial aid qualification is great. I too am a big supporter of matching the child’s earnings and contributing to a ROTH.

    Barbara Friedberg

    August 14, 2013

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