If you’ve ever seen Suze Orman discuss financial responsibility, you probably already know what I’m about to say as my disclaimer, so I’ll just quote her,
“Decide if you can legitimately afford to save for your children’s education or not. With mortgages imploding, adults neglecting their retirement savings and perhaps even lacking any sort of emergency savings, a young couple must put themselves and their needs first so that they don’t become a financial burden on their children later in life. The best way to lay the groundwork for your child’s financial future is to make sure that as parents you have a will, a living revocable trust, and the proper life insurance policy in place in case something happens to you while your child or children are young.”
And with that assumption being made… I’m going to share a little bit of information that I’ve found incredibly helpful on the options one has for investing in their child’s higher education!
First, I found out that there are basically four investment options for college savings:
1) Coverdell Accounts – limited to an investment of $2000/year (and perhaps down to $500/year in the future), tax-free upon withdrawal, can be used for any education expenses (K-16 up until child is 30), can be invested in anything you want, can only contribute if income is less than $220,000 (joint), contributions not tax-deductible
2) ROTH IRAs – limited to $5000/year per person, tax-free upon withdrawal for education expenses, contributions not tax-deductible, can only contribute if income is less than $177,000 (joint), may impede on regular retirement savings
3) 529 Plans - no limit on annual contribution but maximum contribution limit of $100-305k, tax deductions in some states for contributions, tax-free upon withdrawal, prepaid (pay for college now through state funds or the Private College 529) and savings options, managed in mutual fund style (no personal control of assets)
4) Regular investment accounts w/no tax benefits
After looking through our investment options, it seemed like the easiest option for our savings would be a 529 Plan for Baby M. Sadly, California is not one of the 38 states that offers a state tax deduction on contributions, so that meant that rather than easily picking our state’s default ScholarShare plan, we had the chance to shop around for the best plan for our needs.
I called upon the wonderful financial resources of the Internet, and found great things at The Motley Fool (overview on how to select a plan), Bankrate’s Savingforcollege.com (comparison of all state plans), and MorningStar (6 Questions to Ask Before Investing in College and College Savings Calculator).
And then using all of the information that was presented, calculating costs and deciding on investment options and portfolios, we decided to go with Utah’s Education Savings Plan. Their state plan uses Vanguard (which we like for the low fees), has no annual fee for the account if you use electronic debit, it had no minimum required to open the account and it’s FDIC insured.
And thus far, the account has been easier than pie to manage! They have a wide variety of options for reoccurring deductions, so our money just leaves our bank account monthly and we never think twice about it! I like the ease of managing it online through their website and just the security that we’re saving for something now and allowing the most time we can for it to grow. Now, if I could somehow predict that Baby M wanted to go to certain private university (like, say, her Dad’s alma mater), then I may have been swayed with the private prepaid plans.. but sadly I’m not sure any of us can predict what universities will look like 18 years from now… or where our kids will want to go!
I hope that some of the links above can demystify the process for you and help you figure out what your best savings plan is for higher education… and maybe make it a 2 hour research project for you compared to the time I spent!
[UPDATE 08/2011: We’re still really happy with our choice of plans. They now have an “age appropriate” option that changes your investment and risks levels as a child grows older, which really allows you to deposit and look away without too much worry. The fees are incredibly low and their quarterly updates are timely and informative and simple to interpret. We’re very happy with our decision.]