Investing for my Daughter's Future

[Biffard]

Hello Everyone,

I am new to this forum but I have found a lot of useful information here and that leads me to believe I can get some good advice for my question.

I have a 6 month old daughter and since the day she was born my wife and I started putting $100 a month in her own savings account. Once we reached $500 I put that into a short term CD. I was planning on laddering the CD's as time goes on but I am wondering what other investing methods would be recommended (ie Mutual fund, Gerber College Savings Plan, etc)?

I'm not looking to get rich with her money, just pay for college or wedding, so I don't want to be too risky with it.

Have any of you done something similar for your kids and have any advice around what works well?

Hopefully this question makes sense, I'm new to the whole "parent" thing so I'm learning as I go. Overall, I just want to start preparing now for her future.

[cooliemae]

I would suggest opening up a 529 plan and investing the money. Over the course of the next 18 years, the money you invest will see much more growth and money sitting in a CD. The money earned on the 529 plan is also tax free as long as it is used for educational expenses.

Most 529 plans will have a range of options to choose from from very aggressive portfolios to very conservative portfolios. There are a large number of 529 plans available so you'll need to research which one will work best for you. Your state my offer incentives for using it's 529 plan, such as mine in WI which allows me to deduct up to $3,000 of contributions off my taxes. Of course, if you like a 529 plan from another state you can certainly choose them. Sometimes other state's plans have lower cost ratios and/or better investment options. It really depends on you.

You can use the money in a 529 plan for anything you want, just remember that you're going to face a 10% penalty on the profits (not the principle) that are not used for educational purposes.

[Biffard]

Thanks for the reply Cooliemae!

I'm showing my ignorance here, but I have never heard of a 529 plan. I just did some quick research and it seems like a very viable option.

I don't mean to pry but have you had a good experience with your 529? Any advice you could offer if you were doing it over again?

[MonkeyMama]

Biffard - do you know what your tax rate is?

I personally believe the best thing we can do for our kids is take care of ourselves financially. I do not put our money in our kids' names. We set money aside so that if things do go well we can help our children in various ways.

I dislike 529 plans. They are generally meant for the more wealthy. There are many fees and restrictions (has to be used for college, or penalized). I don't get the sense this is the best option for you since you said this money could be used for a "wedding" or for other expenses. 529 could be considered if you expect to use the money for college, if you get a decent state tax deduction for contributions, or if you want to put away large sums and your own income is already taxed heavily. For reference, if your tax rate is 15%, your investment tax rate is 0% - I would not recommend tying up money in a 529 in that case. Unless perhaps your state has a good 529 plan and a very good tax break.

All of the above said, my in-laws give about $100/month to our kids for the future. Is likely not to be 100% used for college, for various reasons. WE invest in low cost balanced mutual funds (Vanguard). When the kids are about 5 years out from college, we will move it over to cash or something more conservative. My one child is only 8 years away from college-age so am not into the aggressive long-term stock approach. More stock was okay when he was 6 months old. We have just gotten more conservative as college/adulthood approaches. Our tax rate is low (investments 0%) so we are not enticed by the tax breaks of education accounts.

You can also consider an ESA. You can put away $2k per year. No taxes on earnings if it is used for college. Again, more restrictive and not ideal if you don't really need the tax break or might not use it all for college. But is generally less restrictive and lower cost than 529 plans.

[cooliemae]

MonkeyMama - I can understand your arguments against a 529 plan, but I don't think they are necessarily for the wealthy of course the 529 plan you choose and the state you live in do matter quite a bit.

Biffard - I haven't had any problems with Edvest, which is Wisconsin's 529 plan. The only thing I wasn't prepared for was the change from Wells Fargo to TIAA-CREF, not that it was a bad thing. I just didn't think about the fact that Edvest is a managed plan under contract and when the contract ends you might have a new company managing the account.

Because WI allows for the deduction, I will actually get about $100 more back from the state than I would have otherwise, which in my mind translates into a 13% return on the $1355 we contributed. I would suggest that if there is a tax break and family members are going to give to the account, have them give you the money and contribute it yourself so that you get the tax break. (My parents live in CO and get not tax benefit, but we would) We've also seen a 6% gain over the last 3 months (since switching to TIAA-CERF) and TIAFF-CERF has a low .21% annual fee.

We choose an age-based aggressive allocation that will continue to get more conservative the closer my son gets to being 18.

MonkeyMama has a good point in that 529 plans are for education and you will pay a penalty on the earnings if you don't use it for education, so maybe a mix of a 529 plan and some low cost mutual funds would be wise.

[sarah]

I agree with opening a 529 plan. College is only going to get more expensive and college graduates make more than non-college graduates

[Biffard]

Thanks for the replies.

I did some more research on my state's (Utah) 529. It has an annual fee of 0.35% which isn't bad. However, I don't like the fact that the money can only be used for school related expensive or else I will be penalized.

The savings are intended for college but that doesn't mean that is what it will be used for. I am leaning towards a Mutual Fund mainly for the purpose of it not being so restrictive.

To answer MonkeyMama's question, my tax rate is 15% and I tend to agree with your thinking around being able to spend the money on something else (ie Wedding, etc) if she decides college isn't for her. I'll still weigh out my options and maybe do some math to try and determine the best way to go.

Thanks for the help and for showing me more options!

[johnnyjs]

There are tons of opportunities right now for income based assistance as well as academic scholarships. My point is there is tons of money out there you just need to know where to start looking. One good option is to expand your search beyond the University's financial aid office and look to banks and other private lenders.

[MonkeyMama]

To answer MonkeyMama's question, my tax rate is 15%

Okay, so your long-term capital gains are taxed at -0-. As long as they are not enough to bump you into the next tax bracket. You can redeem gains over the years periodically (harvest tax gains) to avoid most taxes on this investment. CD or bond interest is taxed at your ordinary tax rate (15%), to be clear.

There is a Utah tax credit for 529 contributions. You may have to use the Utah 529 for the state tax credit. Otherwise, it doesn't matter which state plan you use.

But, your low tax bracket and not wanting to be penalized does rule the 529 as a sensible choice. Too often the blanket advice is "529 for college" whereas it really depends on many factors. You might want to look a bit more into the state tax credit to be sure. But keep in mind 529 plans are laden with fees, restrictions, and potential penalties, too. At a quick glance, the state credit didn't look that enticing. Some states have very big tax breaks.

[Like2Plan]

Okay, so your long-term capital gains are taxed at -0-. As long as they are not enough to bump you into the next tax bracket. You can redeem gains over the years periodically (harvest tax gains) to avoid most taxes on this investment. CD or bond interest is taxed at your ordinary tax rate (15%), to be clear.

There is a Utah tax credit for 529 contributions. You may have to use the Utah 529 for the state tax credit. Otherwise, it doesn't matter which state plan you use.

But, your low tax bracket and not wanting to be penalized does rule the 529 as a sensible choice. Too often the blanket advice is "529 for college" whereas it really depends on many factors. You might want to look a bit more into the state tax credit to be sure. But keep in mind 529 plans are laden with fees, restrictions, and potential penalties, too. At a quick glance, the state credit didn't look that enticing. Some states have very big tax breaks.

I think one of the biggest problems with making the best choice for college savings is a person has to make assumptions about what the tax code will be, what their tax rate and income will be 18 years in the future.
In some cases, the state tax break plus the tax deferred earnings from the 529 plan may not be as favorable as taking the federal college tax credit. But, if federal tax credits go away (or your income level prevents you from qualifying from the federal tax credit), or the ROR on the 529 is fabulous--the 529 might be more favorable.

[cooliemae]

I think one of the biggest problems with making the best choice for college savings is a person has to make assumptions about what the tax code will be, what their tax rate and income will be 18 years in the future.

You hit the nail on the head! Of course the assumption of a 529 plan is that someone is going to use it for post-secondary education. Given that, I look at 529's in a similar light as I would a Roth IRA/401k. Better to pay taxes now and grow tax-free.

Can you clarify why one wouldn't be able to take federal tax credits for education because of a 529 plan?

[Like2Plan]

Can you clarify why one wouldn't be able to take federal tax credits for education because of a 529 plan?

If you use 529 $$ to pay for the qualitfied expenses (for the tax credit), you can not also get the federal tax credit.

No Double Benefit Allowed

You cannot do any of the following.

•Deduct higher education expenses on your income tax return (as, for example, a business expense) and also claim an education credit based on those same expenses.

•Claim more than one education credit based on the same qualified education expenses.

•Claim an education credit based on the same expenses used to figure the tax-free portion of a distribution from a Coverdell education savings account (ESA) or qualified tuition program (QTP).

•Claim an education credit based on qualified education expenses paid with educational assistance, such as a tax-free scholarship, grant, or employer-provided educational assistance. See Adjustments to Qualified Education Expenses, next.

Education Credits

[cooliemae]

If I'm reading that correctly, you can't double dip, but if the 529 distributions don't cover entire amounts, then you can claim those on your taxes.

For example, 529 distribution is $4,000 for the year, but expenses are $6,000. You should be able to claim the $2,000 not covered by the 529 distribution on your taxes.

[Like2Plan]

Publication 970 see Coordination With American Opportunity and Lifetime Learning Credits Chapter 8-page 56 for the worksheet..

[Like2Plan]

If I'm reading that correctly, you can't double dip, but if the 529 distributions don't cover entire amounts, then you can claim those on your taxes.

For example, 529 distribution is $4,000 for the year, but expenses are $6,000. You should be able to claim the $2,000 not covered by the 529 distribution on your taxes.

As with anything with the IRS, it is a little more complicated... I put a link to the publication.