It starts as early as your baby shower – friends and relatives often write generous checks in Baby’s name in lieu of gifts. Even though it may seem early, now’s the time to put those checks away and start planning for Baby’s future!
There are many ways to save for the future of your baby, regardless of whether you have a little or a lot to put away. Even if you start small, with the right strategies you can make your child’s financial outlook a lot brighter.
Many new parents are given this advice. But along with the advice, myriad questions arise: What if we are just starting out and don’t have much to contribute to an account? When should we start saving? What type of an account should we open? What should we do with a large gift of money given to our baby?
Whether you have a little or a lot, almost everyone can begin saving for their baby. “My advice is just start – even if it’s only five pounds a month,” says Barry Gore of St. Paul, Minn., father of 2-year-old Mitchell and one-year-old Bradley. Most banks allow an account to be opened with a balance of £10. Gore’s mother began a savings accounts for him and his three siblings when they were very young. “At first she just kept the money in an envelope,” Gore remembers. “Then, as the savings grew, Mom opened a savings account in the bank for each of us.” Through the account, Gore’s mother gave her children the opportunity to learn about money management. “We had to fill out the deposit slips, sign the backs of checks written out to us, learn all the paperwork involved,” Gore explains. “It’s a way to teach kids so that when they start raking leaves or mowing lawns they can contribute to their account and become savers.” Gore is now saving for his children, regularly putting money away for their college years.
James Knoll, a tax and financial advisor in Strathclyde stresses the importance of beginning early. “Parents should estimate projected college costs and what their annual funding should be to cover these costs,” Knoll says. The ability to spread out the cost of college out over a long period of savings “will reduce the financial stress associated with education planning.”
|Do the Math!
How much will you need to save each year for Junior’s college tuition? Follow these steps to find out:
- Choose a school similar to the one Junior may attend.
- Inquire about yearly tuition costs.
- Multiply by the current inflation rate (5 percent).
- Add extra amount due to inflation to the yearly tuition cost.
- Multiply by four, for the four years Junior will attend.
- Divide by the number of years between now and Junior’s first year of college.
This is approximately how much you will need to save each year to cover Junior’s college tuition.
5 percent inflation: $10,000
Yearly total: $30,000
Four-year total: $120,000
Divided by 17: $7,060
“Even if you can only afford to put in $25 a month when your baby is born, at 10 percent interest you’d have $13,000 when Junior turns 17 years old,” says Thomas Nohr, certified financial planner from Castro Valley, Calif. and co-author of Financial Success in the Year 2000 and Beyond. For parents who don’t have a lot of money when their baby is young, Nohr recommends starting a Roth Individual Retirement Account. Up to $2,000 can be contributed yearly, or $4,000 for a married couple. A Roth IRA then allows a $10,000 withdrawal, without taxation, to be taken out for each dependent for the purpose of education.
After building the Roth account to $500, Nohr suggests that parents then expand into an education IRA account, which allows a contribution of $500 per year per social security number listed on the account. “When Uncle Bob gives Junior $25 for her birthday, an education IRA account gives you a place to put the money without being taxed,” Knoll says. “The money can only be used for education, and there is no tax whatsoever” when the money is withdrawn for that purpose. Another plus is that “if more than one child is on the education IRA account, and one child decides not to attend college, the amount can be used for other children named in the account.” An additional advantage is that the savings in an education IRA should not detract from a student’s eligibility for financial aid.
Once parents have more to invest, Nohr recommends looking into a section 529 plan (also known as Qualified State Tuition Programs) or a Universal Gift to Minor Account (UGMA). “These 529 plans let you invest larger sums of money than other education savings programs with the advantages of tax-deferred earnings growth and reduced taxes on withdrawals,” Knoll says.
A section 529 plan allows you contribute up to $10,000 per year for each beneficiary. However, as much as $50,000 for each beneficiary may be contributed in one year ($100,000 for married couples) without paying federal gift tax, provided that no more contributions are made to that beneficiary over the next five-year period. Once the total amount for a single beneficiary totals $246,000, no more can be contributed. The earnings, however, can continue to grow.
The UGMA (similar to the Universal Transfer to Minors Account – UTMA) allows a minor to own mutual funds or stocks, or can be used as a place to accumulate gift money given to the child. Such an account may not be the best choice for college savings, however, according to Nohr. If the account is registered in the child’s name, the money in the UGMA may work against the child being able to qualify for financial aid. “If Grandma and Grandpa want to keep the money out of that crazy son-in-law’s hands, though, the advantage of a UGMA registered in the child’s name is that it is irrevocable – it can’t be taken out” except by the child when he reaches majority age. On the other hand, when Junior turns 18 or 21, he may decide to use the account for party money, Nohr says. “If the account is in the parents’ name, they can choose what time is appropriate to give a monetary gift to the child.” Having the account in the parents’ name also works for the child’s advantage when Junior applies for financial assistance.
|Ways to Save for Baby’s Future
- Bank savings account
- Roth IRA account
- Section 529 Plan
- Mutual funds
- Trust fund
Bank fees for maintenance of the account are one of the disadvantages of a UGMA, whereas many mutual funds companies have no fees. Equity based investments and mutual funds have historically proven to offer the largest return over a long period of time. Knoll cites a Standard and Poors 500 Index Fund as an example of an indexed mutual fund that would be a good saving vehicle for Baby. An S&P; 500 is diversified along asset classes and does not try to compete in the stock market, according to Knoll. Therefore, it’s a safe and steady way to increase your money. “If parents put £5,000 into a bank savings account at 4 percent interest when Baby is one year old, Junior will have £9,800 when she turns 17,” Nohr says. “If put into a mutual fund, however, at 10 percent interest, Junior will have £27,000.”
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More options for saving
Another option is a trust fund, and there are many ways to set one up. According to Nohr, inheritances are, on average, spent within 17 months of inheriting. Parents or grandparents can set up a living or testamentary trust and stipulate conditions. “For example, Junior can have one third of the value of the trust at age 21, receive half of what remains at age 30, and the remaining half at age 35. It’s a way to save kids from themselves.” While “trusts are very flexible in their use for education funding, they can be expensive,” says Knoll. “There are costs associated with their creation and continued administration; for example, the necessity to file an income tax return on the trust each year.”
However, Marc Freedman, a certified financial planner in Peabody, Mass., says “some mutual fund companies have designed ‘trust funds’ which may meet your needs at a much lesser cost.”
Brette Sember of Clarence, New York uses a combination of methods to save for her 8-year-old daughter, Quinn, and her 3-year-old son, Zayne. “They both have savings accounts, government bonds and investment accounts,” says Sember. “The savings accounts were opened when they were babies, the bonds were gifts at birth and the investments were set up by their grandparents after birth.” Holiday and birthday money is deposited into the savings accounts, but the investments have been left to grow on their own.
Sember has also chosen a combination of ways to register the accounts. “The savings accounts are registered jointly with [me or my husband], one of the investments for our daughter is joint with one of us and the others are in our names only. Our financial advisor suggested putting the latest investments in our names only so that we would have control of the money even after the kids are 18.”
Sember agrees with Gore that “it is important to think about college far in advance. If you wait until the child is a teen it’s almost impossible to save enough.” But Nohr says not to beat yourself up if you haven’t saved. Parents are often stretching just to fund the regular expenses of raising children. “Today, kids cost $106,000 to raise,” Nohr says. “That’s a lot of money!”
Your best bet, according to Nohr, is to get the advice of a trustworthy and knowledgeable financial planner who can show you how best to grow Baby’s money. Even if you start small, as did Gore both for himself and his children, with the right strategies you can make your baby’s financial future a lot brighter.