Friday, November 19, 2010

Saving For Your Children’s Education

Brace yourself for a shock. The average public college education for a child born in 2003 is $95,000. Private college? Up to $240,000. You’d better get ready, or your child will be stacking up a mountain of student loans.

Start saving for your child’s education soon after they’re born. Even if the fund starts small, the longer the account exists, the more time it has to grow. Increase your contributions as your salary increases. Allocate a part of your annual bonus to go toward their fund. Grandparents who like to give your children savings bonds or cash at birthdays can instead make a deposit into your child’s mutual fund where it will make an impact on their future.

A Couple Suggested Funds

A 529 is great option, because anyone can open one, and the money deposited grows tax-free. The money can then be withdrawn to cover college costs without being taxed. You are able to start saving before your child is born. You start by selecting the state plan that best fits your needs based on how much you can invest, how the funds are invested, and the tax ramifications, such as being able to avoid state taxes in addition to federal taxes. Second, sign up using a simple form. After that, you begin to deposit as much each year as you can under the plan's guidelines. Your money is invested and grows completely tax-free, and each plan is professionally managed.

Coverdell Education Savings Account (CESA), formerly known as an Education IRA, will allow you save up to $2,000 a year tax-deferred. The biggest advantage is that funds can be used for elementary and secondary school education, in addition to college. A word of caution: the funds are considered student assets when financial aid is calculated, potentially reducing the amount of financial aid your child will be eligible to receive by falsely increasing their anticipated earnings. The maximum contributions are limited as well, so watch out for administrative fees. They could turn out to be larger in proportion to the dollars saved.

The Rule of 72

This rule is simple, yet all too often overlooked. Take the interest rate you’re receiving on your investments and divide it by 72. This will tell you how many years it will take the money to double. Try it out and you’ll see why the interest rate you get on your money is so important.

As you can see, the rule is remarkably accurate, as long as the interest rate is less than about twenty percent; at higher rates the error starts to become significant.

You can also run it backwards: if you want to double your money in six years, just divide 6 into 72 to find that it will require an interest rate of about 12 percent. Below is a table showing how the rule works.

Rate of Return      Rule of 72      Actual # of Years       Difference (#) of Years

  2%                          36.0                      35                                     1.0

  3%                          24.0                      23.45                                0.6

  5%                          14.4                      14.21                                0.2

  7%                          10.3                      10.24                                0.0

  9%                            8.0                        8.04                                0.0

  12%                          6.0                        6.12                                0.1

  25%                          2.9                        3.11                                0.2

  50%                         1.4                         1.71                                0.3

  72%                         1.0                         1.28                                0.3

 100%                        0.7                         1                                     0.3

Author: John-Michael Haines

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