Archive for May, 2008

Time is of the essence – Part 5 (Kids Education Savings 3)

For the last few posts, I been talking all about Kids Education savings plans by starting with a detail analysis on why its really important to early, continuing with talk on different investment routes to consider. This post I am going to elaborate various savings plans available for education savings and which one is better compared to others.



What savings plan to select?


Of course, you might have heard a lot about different plans in existence for kids educations. 529’s aren’t the only savings accounts that allow parents to shelter their investments from taxes and to withdraw money tax free for college. You also got Coverdell, UTMA&UGMA plans. Lets see one by one.

Coverdell The so-called Coverdell education savings accounts unlike funds in 529s can also be used to pay for primary and secondary school costs. So you can use the funds invested in Coverdell plan for K – 12 expenses which is really good tax break. But the catch, you can only invest a maximium of $2000 per year to this plan.


Also Congress conspicuously did not extend some attractive features of Coverdells, which are due to sunset at the end of 2010. The benefits include the ability to contribute up to $2,000 a year into these tax-advantaged accounts. After 2010, maximum annual contributions into a Coverdell will fall to only $500.


What’s more, K-12 expenses will no longer qualify. As a result, parents now investing their kids’ money in Coverdells “need to give strong consideration to the enhancements of 529s,” says an analyst from Putnam Investments.


While there are chances federal government could extend these beneficial Coverdell provisions, there are no guarantees. But many anlayst still advocates “putting the first $2,000 into a Coverdell and then putting your remaining savings into a 529.” Because under current law, money invested in Coverdells can still be used for K-12 expenses. And unlike 529 assets, Coverdell money is permitted to purchase equipment like computers for kids between kindergarten and 12th grade.


If the K-12 option does sunset in four years, as scheduled, the IRS allows Coverdell owners to roll over their accounts, tax free, into a 529. So why not preserve your options by first funding a Coverdell and then putting the bulk of your money in a 529?



UTMA and UGMA


Let see 2 other plans before I jump into my favorite 529 plan which are UGMAs and UTMAs plan. The Uniform Transfers to Minors Act (or Uniform Gifts to Minors Act) provides an alternative that may be simpler, cheaper and faster than a trust to transfer asset or give gifts to child. It is a custodial account which can help save taxes because this asset is considered as kids and not those of parents. Since kids won’t have tax obligations, they don’t end up paying taxes for this account. This type of plan is mainly used to give as gifts and transfer assets to avoid big Uncle Sam taxes and not really as route for education savings.


There are lots of disadvantages to this type of accounts according to many analysts.


1. Once you’ve transferred assets into a custodial account, you’re not permitted to take them back. Those assets belong to the child. You probably can’t take the assets back even with your child’s consent, because your child isn’t old enough to give valid consent on such matters.


2. When your child turns 21 (or an earlier age, in some states), the custodian must turn the assets over to the child. Some people are mature and thoughtful at age 21 or earlier; many are not. Do you really want all that money in your child’s hands at that age? How will you feel if he/she uses it to buy equipment for her boyfriend’s rock band?


3. This is important concern. Some people think of a custodial account as a good way to save for college, and learn only later that the account causes a reduction in financial aid. Under current law, assets owned by the child count much more heavily than parental assets in determining how much financial aid the child qualifies for. By law, a custodial account belongs to the child, so having large amounts of savings in an UGMA or UTMA is detrimental for qualifying for aid. Meanwhile, 529 assets are not considered student money for financial-aid purposes, according to recent federal rulings.


I found an article talked about a recent analysis by T. Rowe Price comparing 529 and UTMA’s. Say you put $5,000 a year into a 529 for your daughter, and it earned 8 percent annually through investments in a blue-chip growth stock fund. After 18 years, you would end up with more than $218,000 for her college bills. By using a home-state 529 plan that offers residents a state tax deduction, you’d be likely to amass nearly $224,000, T. Rowe Price found.


Now compare that with what you would save through an UGMA. Under the old rules, a typical parent in the 25 percent federal tax bracket could expect to accrue around $210,000 in the custodial account, according to T. Rowe Price. But under the new rules, you’re likely to save even less: $207,700. Plus, UGMAs and UTMAs are terrible from a financial-aid standpoint. As a rule of thumb, it’s always better to save money in the parent’s name, since Uncle Sam expects only 5.6 percent of parental assets to be used to cover college expenses. By contrast, the government will assume that 35 percent of the student’s money can be used to pay for school (in the 2007-08 school year, this will drop to 20 percent).


If you’ve already started saving through an UGMA or UTMA, don’t worry. Parents can roll over these accounts into a so-called custodial 529. While the money will still technically belong to the child, the assets will not be counted as student assets for aid purposes, even though the account maintains custodial status, the federal government recently said. 529 Savings plan 529 plans are the best of its kind next to Coverdell which can used as a nice vehicle to storeaway reasonable amount of money for your kids education. It’s doesn’t have any drawbacks like UTMA or UGMA but it can only used for College education unlike Coverdell can be used for K-12 expenses as well. There are 2 types of 529 plans. Prepaid plans offered mostly by institutions and states. Saving plans are offered by States and Mutual fund management firms.




The Prepaid plans are getting famous these days. Prepaid tuition plans allow parents to purchase units of future education at today’s prices. Earlier this year, the government gave these college savings vehicles a big boost by improving their financial-aid status. Under the old rules, the value of a prepaid tuition plan would reduce a student’s aid eligibility dollar for dollar. But starting in July, the government put prepaids on a level playing field with 529 savings plan. Both savings vehicles are now beneficial for qualifying for aid since they are not considered student assets. Even if you intend to use a prepaid plan to save for school, though, you will still probably want to start a 529 savings plan, too. That’s because prepaid plans are good only for covering tuition and fees. They don’t typically cover room and board. And in recent years, room and board has become nearly as expensive as tuition at many schools.


The ordinary 529 savings plans on the other hand is a transparent plan which you can signup with a Mutual Fund firm or State sponsored plan supported by a fund management company which manages the funds. It is not necessary that you need to get a state sponsored fund to use it in the institutions in that state. Its just yet another fund specialized in certain criteria.




Why 529 plans?


1. Great tax break. Money grows tax deferred and you can withdraw money tax free when you kid is eligible to use it.


2. You are in control and its your money. It’s not considered as kids money anytime.


3. It is easy to setup and control with underlaying funds managers who control the growth of the fund.


4. No limitations of income and contributions.



One more tip, when you spend your dollars you can put away a part of it to your kids 529 plans. Its a hidden savings when you signup with UPROMISE. There is no catch. You just need to attach your credit cards and is automatically contributed on special purchases to your account.


The bottom line, no matter what type of college savings vehicle you now use, you probably need to consider opening a 529. The recent changes by the government really made the 529 more attractive relative to all other college savings vehicles out there.


Check out the websites Savingforcollege.com and Upromise.




I will share my 2 special funds which I started for my son in my next and last post on this series. Watch out..



Time is of the essence – Part 4 (Kids Education Savings- 2)

We are now on the 4th part of the topic “Time is of the Essence” as I continue to discuss how a timely decision can make a big difference in all of our financial well being. I am just trying to stress how much time matters by providing real examples and solutions. Hope its helping you to make your decision. That’s the key aspect of these blogs.

If you missed out on blogs “Compound Interest Magic“, “Life Insurance Play“, “Kids Education Savings – I“. Check them out before you read on this part. In the Kids Education Part – I, I tried to provide a detail analysis on why Kids Education savings is really needed?! I myself thought a lot about it until last week I made my mind for my sons education.

I finally made my decision to start 2 plans(Coverdell&Vanguard 529 plan) for my son who is just going to be 2 years in a month. It’s the right time to kick start something for his futre which should be ready when he hits 18years for his college.

Which Investment vehicle to choose?

Too many choices is always a problem. When you go to Walmart to just get a box of cereal. You are sure to be startled with a whole aisle full of Cereal boxes. It’s not an easy task to select one from umpteen number of brands and different type of cereals as everyone of them is best do its job as a breakfast item. Unless you know what you are looking and what you want, it is tough job to handle.

Similarly there are lot of different options in this market to make your money grow especially when it comes to kids education. It all depends on which route you want to take and what amount of risk factor you can manage. Let me tell some which I myself researched before I made up my mind.

CD Savings

The first vehicle which always comes to average individual mind is CD’s. Certificate Deposits is a good way to start savings. Actually I started my son savings as a CD which yielded 5% but not anymore. But it helped me to atleast get to an habit of putting certain amount aside for this savings.

I would also suggest you to start as a CD and try to see whether you can put aside certain amount every month for kids education. Once you got an hang off this monthly routine, just plan to move over to a different vehicle because CD’s don’t yield a lot of return especially at this economy where a CD only yield a max of 4%. With 3% average inflation, you are only gaining 1% on top of it. You need to find a vehicle which can yield atleast 8-10%.

Real Estate

Next comes Real Estate in my list. I like this route for many reasons to make your money grow but not for Kids 529. It gives lot of leverage for your money, good cash flow and adds equity to your home which is a good ROI.

But if you think for a long term, it might not be a right tool. Depreciation’s and Appreciations just doesn’t work well together. An analyst from Market watch just reported in an interesting article a month back, comparing Stocks and Real estate returns. A dollar invested in Stock market came out as 12.83 cents after 25 years where a it only yield .83 cents in real estate with all inflation and everything put together. That might be surprising for many but that’s a truth if you take only equity. So I don’t really agree with him 100% but I still don’t like real estate being a vehicle for kids education.

Stock Market

I know lot of stock brokerage firms offers you this option to open a 529 stock account to invest in stocks. I myself thought about it but stayed away. It’s a smart idea for many stock savvy investors but not for an ordinary individual like you and me. I am swing trader in stock market but that doesn’t mean that I am stock savvy investors. It is good route because it always beaten any other investment vehicles all the time if you know how to play. If you don’t the battle field, you are determined to be crushed to death. So I won’t risk my money especially when I need to save and get a good ROI to back me up after 15years.

If you would ask me, You should only put the money what you really don’t need for any purpose into the stock market. That’s the smart investors mentality. You shouldn’t put anything you really need today or tomorrow as you have the high probability of losing it in stock market.

Mutual Funds(MF)

Last but the most opted-in solution. MF’s are the right choice according to many analyst when it comes to Retirements, Kids educations or for any long term savings for that matter if you know the right company and right fund to invest. I know many might agree with me because its one of the safest route available for any individual who likes hassle and stress free shopping.

But there is a caveat to this path. You should be willing to invest atleast some amount of time to do proper research on selecting a fund company which offers low expenses, low monthly deposits and has funds with proven record. You shouldn’t just choose any MF’s in the market to do work for you.

You need to select funds which has real good history of returning atleast 10% and market proven record. It also important to keep in mind to select a Tax deferred education plan instead of usual taxable Mutual fund. The core advantage of tax deferred is to make your dollar grow better without giving to uncle sam every year during tax season. It is the big difference between taxable funds and tax deferred funds.

Conclusion

To conclude, I would strongly recommend anybody to go with Mutual Fund route choosing a right fund company and right fund to grow your money. If you are well versed in Real-estates that would be next choice.

Having recommended Mutual fund to be my first choice, I should talk about proper education plan to work with it. There are different kids of plans like 529 plan, cover dell or UTMA which is totally different and has advantages of their own. We will talk more in detail on the next blog and I will also reveal my personal funds of my choice which I selected for my son’s education.

Time is of the essence – Part 3 (Kids Education 529 Savings)

In the last 2 posts, I been taking about how Time can make a ton of difference. We have seen “Compound Interest Magic” & Life Insurance Play. This post we will see how important to start saving for Kids College education earlier the better.




We all know the greatness of good education. We also very well aware, good education is real important for our kids future. But Kids college education is not cheap and affordable anymore. It’s getting more expensive every year with an average increase of 6-7%.





For this sole reason, not many parents are able to afford this increasing price tag for their kids education. Important truth, they missed out on saving for their kids education earlier. If you start thinking and plan to take action on saving for kids education now, you can beat the crowd to educate your kids.

Why you need to start now?

According to an article in thinkfinancial.com, the cost of college savings grow 5-6% every year.




The article also says, a student could get away with spending $433 a year in 1975 for an average Public School, or $2,272 per year on average for a private school. Today one would expect to pay approximately 10 times those amounts. The 2005-2006 college year ended with an average Public School cost of $5,491 per year, and the average private school costing $21,235 yearly.


Over the past 10 years the average private school tuition has increased at a mean of 5.8% while the public colleges have increased more rapidly at a mean of 6.9%. Taking these averages and applying them to future years can give us a rough estimate of what a year of college may cost down the road.


Ten years from now in 2017-2018 with current tuition rate percentages (5.8%), the average cost of one year at a private college is estimated to be $41,771, while public schools will average tuition of $12,228 per year.


Twenty years from now in 2027-2028 with current tuition rate percentages (6.9%), the average cost of one year at a private college is estimated to be $76,406, while public schools will average tuition of $23,832 per year. The above discussion took only Tution fees into account.You still have lodging, boarding, books, transportation and other expenses. If you add all up together, the sticker price for 4 academic years at a typical public university can go to $200,000 to $250,000. The cost of a year of college rose by about 6 percent in 2006, outpacing wages, inflation, or financial aid, the College Board reported today.


In fact, the cost of obtaining a degree is rising even faster because students are taking longer to graduate. Instead of paying for four years of college, the average public university student pays for more than six years of tuition before marching off to “Pomp and Circumstance.” Private school students finish quicker–taking 5.3 years on average, stated by another article.


All the above detail charts only show that you can expect to see a high bill for your kids college in 20years. Instead of worrying about, just take action atleast in a small way.


I will continue College savings talk in the next part on “Which vehicle to invest?”, deMystification of Kids Education Plans and how you can start small. Watch out..

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