When our first son was born in 2008, we wanted to set up a savings
plan that would grow with him over the years. I mistakenly thought this would be an easy decision and casually strolled into our bank with a check and babbling baby in arms.
But it wasn't as simple as I had envisioned. I was blindsided by myriad savings tools available, each containing various risks and benefits.
My financial inexperience coupled with a growingly impatient infant made the process daunting. I cowered in the face of indecision, opting instead for a regular savings account
even though higher-earning plans were out there.
Three years later and none the wiser, I re-entered the same building and scenario, this time with two children in tow. After our second son arrived, I naively thought I'd be able to make a better choice. I wanted to pick a more sensible plan for him and transfer the funds
we had been saving
for our oldest son into the same type of account. But once again, I was intimidated by the countless options and feared the unknowns.
Fortunately for our family, time is on our side -- and lucky for you, some of the groundwork has been done. A few savvy financial experts who provide advice to hundreds of families each year
have weighed in on this subject to come up with three of the best savings options for parents ready to invest for their child's future.
529 COLLEGE SAVINGS PLAN
In a nutshell, 529 plans -- so named because they are authorized by Section 529 of the Internal Revenue
Code -- were created as a simple, tax-advantaged way to help families meet future college costs. And if college savings is the goal, 529 plans make sense because of their tax advantages, flexibility and the fact that you retain control of the assets.
"If you have a pretty good idea that at least one of your children is going to college, then the 529 is the way to go," said Gil Armour, a certified financial planner
for the past 18 years who works at SagePoint Financial Inc. in San Diego.
A 529 savings plan is typically based on the performance of mutual funds and has no guarantee
on returns -- in other words, it's subject to market risk
. Another option
many states offer
is the 529 prepaid plan, which allows you to lock in the current college tuition rate and start paying for it well in advance of a child's enrollment in college. While this might be a good option
for higher-income families and a great way to hedge
against future inflation
, the founder of 1650 Wealth Management
in Florida, financial planner Thomas Balcom, warned that it's not cheap. Pre-paid tuition plan removes market risk because you are buying tuition as opposed to investing
in securities that you will
later sell to pay for tuition.
The 529 savings plan is a great long-term option
and it's a solid way to invest small amounts of money
for college while participating in market gains
. While plans vary from state to state, a 529 makes sense for some families because of its tax advantages -- including tax-deferred growth, tax-free withdrawals, gift tax
incentives and state tax deductions
for some state plans -- and its flexibility, which includes higher contributions, a range of investment options
and almost no restrictions on where your child goes to college or which state 529 plan you choose.
Additionally, you can tailor this plan to your goals, scaling back on aggressive investments as high school graduation approaches.
"It might be more heavily invested in stock
when your child is 5 years old, but gradually over time, it becomes more conservative, which means lower risk," said Mary Voll Miller, a certified financial planner for Per Stirling Capital
Management LLC in Austin and mother of two teenagers nearing college.
And if you choose a good plan with a solid track record, you don't have to constantly monitor it.
"You have a glide path," she said. Another silver lining: if the child opts out of college, you can change the beneficiary
of your 529 account to another family member.
Cons: If you don't know that at least one of your children is going to pursue higher education, a 529 isn't your best bet.
And with the potential for higher returns also comes the possibility that your savings investment
could decrease in value. Think back to students entering college in 2009 after the stock market
crashed in 2008, Miller warned. If students' 529 plans were invested aggressively, some went down in value by as much as 30%.
also come with a few strings attached as to how the funds can be used -- they must be used for purposes deemed as qualified education expenses. Otherwise, "the growth of the principal
if withdrawn for non-qualified expenses is subject to income tax
plus a 10% penalty," Miller said.
You can open
a Uniform Transfer to Minors Account (UTMA) or a Uniform Gift to Minors Account (UGMA
) at your local bank or credit union
. While the earning potential
isn't as high as other options
, this is an ideal choice for shorter-term goals or risk-averse people.
"If somebody can't sleep at night because a value of a savings vehicle goes down, this option
would be just fine," Miller said. "But it's important to be aware that inflation is ever-present and that over time if there is no growth, your purchasing power
would go down."
Pros: It's easy and safe. You can keep adding to it over the years.
You won't earn much with interest rates at record lows
, and the child legally gets all the money when they reach the age of majority -- 18 or 21, depending on state laws -- without any stipulations that it must be used for college costs, which could be a problem if he or she is financially irresponsible.
"This is an irrevocable gift to the child," Miller said. "An alternative would be to open a regular savings account in your name and earmark it for the child so if you ever needed that money back, it would be accessible."
CUSTODIAL BROKERAGE ACCOUNT
For broader savings purposes that don't necessarily include college, financial planners give a thumbs up to custodial brokerage accounts.
"Withdrawals can be used for any purpose on behalf of the child, and there are minor tax advantages regarding treatment of the earnings
," Armour said.
For those who don't consider themselves particularly financially savvy, Miller said opening a custodial brokerage account at a discount brokerage is "very, very easy to do" and recommends seeking out the amazing array of beginning investor information provided by large mutual fund
companies such as Vanguard or T. Rowe Price.
Pros: If you wanted to be as flexible as possible, Armour said custodial accounts are your best bet. They are inexpensive, easy to set up and provide a solid way to set aside money for any purpose for your child. Unlike 529 plans, which are tracked by a parent's Social Security number, custodial accounts are filed under the child's Social Security number. That means any taxable consequences are set at a lower child's rate rather than the parents' rate up to a certain dollar amount; these numbers can change year to year. These funds can be used for anything on behalf of the child -- whether it's a car or summer camp -- which is one of its biggest advantages over a 529.
Cons: A drawback of custodial brokerage accounts is that you are subjecting your savings to the risk of loss when you buy securities, Miller said. Custodial accounts are gifts to the child, and the funds become theirs at the age of majority, which could become problematic if the spending goals of the parent and child differ.
The Investing Answer: If college is on the horizon for at least one of your children, a 529 plan is the best vehicle by far because of its tax-free withdrawal features and relatively high contribution limits. For broader uses that span past higher education, custodial brokerage accounts get the nod. For our family, opening a 529 plan was the clear choice because we know saving for their educational future is our goal. But every family must choose an option based on their goals and financial situation. However, one investing principle is universal no matter which plan you choose: The earlier you are able to start saving for your child's future, the better.