Saving For College

Start Saving for Baby's Education Now!

Many first-time parents do not realize the expenses associated with raising children and preparing for their future. In addition to the diapers, car seats and strollers, there are expenses for day care, private school and college tuition -- and they can put a big dent in a family's budget.

If you weren't born with the name "Rockefeller," don't worry. The most important things are to realize how much you can afford to invest and save and how soon you can begin doing so. The sooner you begin, the less money you will have to save each month and the more interest you will earn.

Close to 73 percent of parents are currently saving for their children's college education but the problem is the amount and the investment vehicle used. Savings accounts are a safe, sure way of saving money, but they earn less than the rate of inflation and earnings are taxed annually, based on the parents' income. And because of their easy access, they provide temptation for the saver.

CDs safe but return is low

Certificates of deposit, another vehicle for short-term savings, may yield interest at a rate of 4 percent or 5 percent, but are still considered too conservative for parents with long-range goals. CDs usually offer a guaranteed rate of interest for a specific period of time, from one year to five years. The issuing institution -- bank, credit union, or savings and loan -- allows you to choose the length of time that your money is on deposit. Typically, the longer the term, the higher the yield will be. Be careful of penalties imposed for early withdrawals. Sometimes the penalties can be greater than the amount of interest earned, and you could lose a portion of the initial investment.

While a savings account may work well for immediate day care or private school needs, more profitable programs can prove to be invaluable for long-range plans, such as college. One long-term option is a trust fund, providing money for a child when the child becomes an adult. Trusts are usually set up in the child's name, by parents or relatives and reduce the estate of the giver.

Similar to a will, a trust is a legal document that holds property or assets for the beneficiary to receive at a designated time in the future. The money can be given in one lump sum or in intervals. Trust funds can be established at banks, credit unions, and savings and loans, and some mutual funds also offer trust funds. Each issuer of a trust fund determines the amount required to open the account, as well as the interest rate and restrictions on withdrawals.

Any interest, capital gains or dividends earned from a trust fund are taxed at the child's rate. When you set up a trust fund, you're teaching a child to invest money and watch it grow. It is a great financial learning tool for the child, but not a great investment because of the low earnings potential.Some states require you to file a trust document with them, so consult with an attorney specializing in estate planning before establishing a trust fund.

Saving with the state

To make sure your child will use the investment money for education, many parents are taking advantage of qualified state tuition programs, that allow them to start saving money for their child's college education in installments.

Sponsored and administered by state governments, the programs also allow parents to defer taxes on their investment income until the children enter college. Some drawbacks of this option include not having control over how the money is invested and not being able to move it to a different investment if you don't like the results. As with any investment or savings plan, shop around.

If you can afford to start saving money early and consistently, consider long-term investment programs such as education individual retirement accounts (Education IRAs), mutual funds, or stocks and bonds.

Education IRAs can be established with after-tax contributions of as much as $500 annually for each child under age 18. You can set up an Education IRA at any bank, credit union or savings and loan. Distributions must be used for tuition, fees, room and board, books, supplies and equipment at a post-secondary institution. The interest earned on an Education IRA depends upon the rate offered by the financial institution, and it is not taxed if used for education costs. Compare rates carefully before investing in an IRA.

One drawback of an Education IRA is the $500 maximum contribution per year. According to the College Board, tuition is climbing at twice the rate of inflation, so a $500 annual contribution will not produce a sizable investment.

Stocks risky, but returns better

Stocks and bonds are long-term investments for the aggressive investor. When you buy stocks, you acquire shares of a company's assets. If the company performs well, you may receive periodic dividends and later, you can sell the stock at a profit. If the company does not perform well and the stock price falls, you could lose some or all of the money you invested.

Bonds are considered to be a safer investment than stocks because bondholders are paid before stockholders if a company files for bankruptcy. The likelihood of a company defaulting on its bonds is rated by agencies such as Standard & Poors, and you can find those ratings at your local library.

Parents are investing in long-term bonds and stocks for their kids, because stocks are averaging 8 to 10 percent over a long-term period. Mutual funds are very popular investments and are professionally managed. A fund manager invests your money in a combination of stocks and bonds and money market accounts, and decides the best time to buy and sell. Because you are investing with a large group of investors, your risk of losing money is diluted.

There are several types of mutual funds with varying degrees of risk. Most mutual funds charge fees and you have to pay income tax on your profits. Keep at it.

The bottom line when it comes to saving is to begin early, invest consistently and try to put away enough money for college and beyond. There are several investment options and the best method of saving for your child's future depends upon how much time you have to save and how much risk you are willing to take. Look for investments that will outpace the cost of living, but be aware that not all investments will make money. The greater the expected rate of return, the greater the risk, and past success is no guarantee of future performance.