It can be so tempting to buy your child or grandchild that hot, shiny new toy. Their faces will light up and you know they will be thrilled with it for weeks, maybe even months afterward.
Emotions aside, toys and gadgets don't grow in value, and in the hands of a rowdy youngster, they probably won't last that long.
So this year, as everyone's mind turns to money, you may want to consider a slightly more valuable gift for your young loved one.
We've all received a $20 bill in a card and probably a U.S. savings bond. But let's think bigger. Consider:
Adults with a bachelor's degree earn an average of $51,554 per year, according to the 2004 U.S. Census, while those with only a high school diploma earned an average of under $29,000 per year. That's a difference of around $23,000, so if you work from ages 23-65, that's $966,000. Adjust for inflation and we're well over $1 million.
OK, good start. But college isn't free and it's not getting any cheaper. The average price for in-state students at a four-year public university was about $6,200, according to the nonprofit College Board's annual survey of college costs. A private university could run you as much as $23,000 per year.
Add on to these dizzying numbers the fact that college tuition increased at an average rate of nearly 7 percent per year between 1958 and 2005, according to Finaid.org. General inflation only rose around 4 percent per year over that same period. Eighteen years from now, there's no telling how these numbers will change, but it's a good bet that they won't be going backwards.
Hopefully, the financial urgency of a college degree is now clear. So, let's jump into planning.
The Power Of A 529 Account
A "jack of all trades" during his 20s, Jason Meulemans tried several different professions ranging from artist to auto mechanic to insurance specialist. It eventually became clear to him that he couldn't advance his career as he'd hoped without a college diploma. He enrolled as an adult student and quickly realized the whopping cost of college.
When his first son, Jackson, was born last year, the St. Paul, Minn., native knew it was in his family's best interest to start saving early for college. Given his background in the financial industry, he turned to the ever-powerful 529 account.
"It was a prudent decision to utilize a college savings vehicle," he explained. "In addition, a post-secondary education really pays tangible returns. I want my son to be everything he wants to be and college broadens these horizons for him."
A 529 plan is designed to encourage saving for future college costs. The plans are sponsored by states, state agencies, or educational institutions and are authorized by Section 529 of the Internal Revenue Code, according to the Securities and Exchange Commission.
There are some significant benefits to a 529 for both the saver (most often a parent or grandparent) and the future college student. Earnings on a 529 account are not subject to federal tax, and usually not state tax, as long as withdrawals are spent on college expenses. But like a 401(k), if you take it out for other reasons, you're going to pay tax and a penalty.
A donor can put up to $12,000 per year into the account without having to pay a gift tax. That may not seem like enough to pay for a college education, but each parent and each grandparent can give that amount each year. You can contribute up to $60,000 in one year, but then cannot give again for five years. This can drastically reduce the value of an estate.
The downside is that not all states allow you to deduct contributions to a 529 account.
Finaid.com has a solid rundown of which states allow 529 income tax deductions and the limits on them.
One important thing to remember when considering a 529 is that each state runs them differently. The Securities and Exchange Commission suggests you ask the following questions before deciding on a 529:
Is the plan available directly from the state or plan sponsor? What fees are charged by the plan? What are the plan’s withdrawal restrictions? What types of investment options are offered by the plan? Does the plan offer special benefits for state residents? What limitations apply to the plan? Who is the program manager?Other College Savings Options
In addition to a 529 plan, parents and guardians can also chose a Coverdell Education Savings Account. Like an individual retirement account, CESAs have annual limits on how much you can contribute.
The CESA is the only education savings plan that can be used for K-12 education. And unless Congress extends that provision, it will expire in 2010. Contributions stop once a child reaches 18 years old, and the money has to be used by the time they are 30.
Custodial accounts -- Uniform Transfers to Minors Act (UTMA) or Uniform Gifts to Minors Act (UTGA) -- are also options for parents.
According to fairmark.com, custodial accounts are somewhat similar to trusts. Both place property under the control of a person who isn't the beneficial owner -- the person who has the ultimate right to enjoy the fruits of the property. In the case of a trust, a trustee manages the property for the benefit of the beneficiaries. In the case of a custodial account, the custodian manages the property for the benefit of the minor.
When it comes to applying for financial aid, the assets are in the child's name, not the parents'. Also, once the child reaches the age of majority -- either 18 or 21, depending on state law -- they can do what they want with the money.
While college can be a great time for personal growth in your child's life, they may not be prepared to manage huge amounts of money.
401K or 529?
In a rugged economy, it can be hard to keep a long-term financial vision in mind while just trying to put food and clothes on a child. Plus, at what point do you sacrifice your own financial health for your child's education?
Many financial advisers are quick to point out that you can take out a loan for college, but not for your retirement. This adage is not lost on
Minneapolis-based financial adviser Nicole Middendorf, who has a young son for whom she recently started a college savings account.
"There's the analogy of the airplane," Middendorf said. "What do they say you are supposed to do if something happens? You put the air mask on yourself and then on the person next to you. If you don't take care of yourself, you cannot help the person next to you."
