Little Jack's CornerThe Life & Times of Jack-Evan and Family

Many of you who know me know of my love of investing and saving for the future.  I’ve had a 403b retirement account since I was 21 (go me!), my husband has his 401k, and we also have a ROTH IRA.  A plan to have our home mortgage paid off in 10-12 years is in the works, and we are currently studying up on owning & investing in rental properties (preferably 10+ unit apartments) and land. 

So, for now, our far-down-the-road futures seem to be taken care of.  Maybe we’ll retire when we’re 45?   

Yet, with all of our planning, we are behind on investing for our child.  I’ve researched investing plans, and at one time was going to open up a Coverdell until  I realized you had to have a social security number for the child in question.  And of course, since we had no children born yet, I couldn’t provide one.  So things just slipped into the back corner.

Now, with the birth looming in 3 short months, we’ve decided to get on the ball with Little Jack’s savings.   Over the past few weeks we’ve scrounged for change in all sorts of odd places, emptied our piggy banks, and stashed away any cash or checks presented to us at baby showers or “for the baby”.  

Then we opened a high interest savings account and plopped in a total of $147.50 for our baby.   It’s not much, but it’s a start, right?

The plan now is to continue with contributions to it until it reaches the minimum amount required to open a mutual fund for him at our brokerage, T ROWE PRICE.  It’s undecided now as to what type of account we will use.  For those of you who are unfamiliar with ways to invest for your child’s future, I’ll go over what I’ve learned.

High Interest Savings Account

• Best % rates are found with online accounts (HSBC, ING Direct, Emigrant Direct)
• Good for short term, but won’t earn much in the long run
• No risk, FDIC insured, won’t lose capital
• Interest rates fluctuate over the years, but typically remain low
• Money can be taken out at any time
• Interest is taxed
• No special rules apply to use

529 College Savings Account

• Tax-free growth (when conditions are met*)
• Money must be used for college expenses to be tax free
• Money is typically invested in the stock market…
• …Riskier investments, possible loss of capital
• Research is needed to determine the best investment choices (stocks, mutual funds, bonds)
• Weighted / Timed mutual funds are available to coincide with your child’s age (aggressive growth at first, then remodeled for more conservative capital retention as your child approaches college age)
• Owned by the Parent (which is great for financial aid considerations)
• Many states provide their own acounts with great benefits
• Transferrable to another child
• Transferrable back to the parent if child doesn’t attend college

Custodial Account

• UTMA (Uniform Transfer to Minors Act)
• Opened in the child’s name & SSN
• Parents are custodians of the account until child reaches 21
• Can be used by the parent to provide provisions to the child
• Child takes posession at age 21 and then can spend as he sees fit
• Under age 14, distributions are taxed under the Kiddie Tax Provision
• Counts heavily against the child for college financial aid

Pre-Paid College Account

• Operates like a 529 Account
• Allows you to lock in today’s tuition rates to pay for tuition in 18 years!
• Helps you beat the typical 6% college tuition yearly inflation rate
• Considered a parental asset (thanks to the 2006 Pension Protection Act)
• Tied to a certain group of specific in-state public universities, or a group of private universities
• Many states offer payment plans
• Typically not transferable to another group

Coverdell Educational Savings Account

• Previously known as Educational IRA
• Works similarly to a ROTH
• Considered a parental asset
• Distributions are tax free for any educational use from Kindergarten to College (*Until 2010)
• Can not be transferred back to a parent, all money eventually goes to the child
• Difficult to coordinate with Hope & Lifetime Learning tax credits
• Money must be withdrawn for education before child reaches 30 in order to remain tax-free
• Has a low yearly contribution limit
• No contributions allowed after child reaches 18

ROTH IRA

• The individual parent is the owner
• Has a yearly contribution limit
• Earnings (interest / growth) are heavily taxed if withdrawn before parent reaches 59
• Contributions (money you put in yourself) can be withdrawn tax-free  at any time because tax was paid up front before you contributed it
• Invested in the Stock Market (Can be safe or risky, depending on your stock choices)
• Alternative to other educational savings if college isn’t forseen in your child’s future
• Good choice if parent is not planning on providing much money towards child’s college
• If parent is beyond age 59, all money can be withdrawn tax-free if account has been held for 5 years
• Remains a part of the parent’s retirement portfolio if money is not used for education

….so that’s what I know.  We were once considering a Coverdell ESA because of the ability to use it for education before college – but we’ve now learned that there is a possibility that this benefit may cease in 2010. 

I like the idea of using a ROTH as a savings vehicle, because at this time Kevin and I are undecided about how much we’d like to contribute to college costs.  We don’t want our child saddled with thousdans of dollars in student loans, but we do want to encourage them to look for grants and scholarships, along with working their own jobs.  However, if the Coverdell benefit of tax-free K-12 education distributions ends in 2010, we’ll most like end up focusing on splitting savings between the 529 Account and a regular savings account – one will be for college, another as a gift for his 21st birthday.  Hopefully by that time he will have at least some investment gumption about him and not frill it all away partying.  But if he does, that’s ok too.  Our gift to him will be just that – a gift.  He’ll learn from it one way or another (partying and losing it all, or investing and seeing it grow).