Where is the best place to start saving for a new baby?
We recently had our first child and would like to start saving for her. The idea of a 529 plan doesn't seem appealing because of its limitations and the rising cost of college tuition which a 529 won't cover, but we can be convinced otherwise. What is the best way to start saving for her?
I'd like to put a an alternative idea on the table for you to consider, a life insurance policy. Here are some of the benefits of what the industry calls “juvenile insurance:”
The potential for substantial cash accumulation.
Obviously, the premium on a newborn is extremely low, as the cost of insurance is minimal. At the same time, certain products are designed to maximize long-term cash growth on both a guaranteed and a non-guaranteed basis. In 20, 30, 40, 50 years, the available cash can be quite high. It is liquid, and tax-free, if the distribution is properly managed.
Entering adulthood already insured.
People start really thinking about life insurance when they grow up and take on responsibilities. They get married, have kids, apply for a mortgage. Start a business. Of course, they pay the going rate for somebody their current age. But if their parents had had the foresight to insure them at an early age, they will have saved a ton of money!
As you know, insurance underwriting assesses many different risk factors. These include current health, medical history, lifestyle, hobbies, etc. When people get older, they take on risks. Maybe, unfortunately, they develop a medical condition that runs in the family. Maybe they take up an adventurous hobby like rock climbing or scuba diving. Maybe they take on a job that requires travel to remote regions in the world.
Any one or all of these factors can raise the price of a new policy. Some of them may unfortunately disqualify them from coverage at all. But if they already have a policy, then no worries.
Something to think about.
Congrats on the expanding family!
My favorite place for young parents to start is their own IRAs — either Traditional or Roth depending upon your current tax bracket and longer term tax outlook based upon your earnings potential.
Why the regular IRA(s)? (It is probably not what you expected) Flexibility. There is an exception for early (before age 59 1/2) IRA withdraws where you do not have to pay penalties if you are using it for qualified higher education expenses. According to the IRS, "Qualified higher education expenses are tuition, fees, books, supplies, and equipment required for the enrollment or attendance of a student at an eligible educational institution." Almost all accredited higher education schools qualify.
What this means is you can each save and invest on a tax deferred basis (possibly tax free with a Roth) and have the optionality down the road to use the funds for your child(ren) or simply retain them in your own accounts for your own needs. Depending upon your child(ren)'s goals, needs, scholarships, etc., they may not need college funds. If they do, having the funds in your IRA(s) is also generally more advantageous from a financial aid standpoint.
So here is a good general starting point for a young couple:
1) Contribute at least the amount to employer retirement plans (e.g., 401(k)) that is matched by the company.
2) Pay down any high interest debt, such as credit cards.
3) Build a little bit of savings so if the car breaks down, you do not have to tap into your IRA(s) and distribute your savings plan. The needed level here varies depending upon your situation.
4) If possible, max out your IRA contributions each year for each spouse.
Also, keep in mind that you can withdraw $10,000 from an IRA, without early distribution penalties, to use towards the purchase of your first home (if applicable).
Life presents many unexpected challenges and takes many unbelievable turns. Flexibility is key.
Joshua Hall, ChFC
Congratulations on the birth of your first child! I have two of my own and know first hand that there is no bigger joy than being blessed with a child.
I also want to congratulate you on being prudent in planning for your child's future and college expenses. I would caution you that discounting the benefits of 529 plans would be a mistake. I have a 529 plan for my kids and it is a great tool for college saving.
Here are a few benefits that come to mind:
- All funds in a 529 plan grow tax-free. Because there is no capital gain tax expense, you are potentially able to save more money for college vs. simply saving in a taxable investment vehicle.
- Contribution into 529 plan might be state tax deductible. This varies from state to state, but can be a great incentive to put money in the 529 plan. I know in the sate of NY, a married couple can contribute up to $10,000/year and deduct that contribution on their state tax return. And believe me, NY residents need every deduction they can get.
- 529 plan are transferable - this means that if one of your children doesn't go to college or better yet, gets full scholarship to college, you can use the funds in the plan for any child or family member.
- 529 plans have low fee structures ( this is a general statement. You must understand the plan you invest in).
- In most plans, you have the ability to pick the type of investment you think makes best sense for your child's education expense goals.
- You are in control of the funds vs. the beneficiary.
That being said, there is a disadvantage of sorts. if you withdraw funds from a 529 plan for purposes other than education related, there will be a 10% penalty plus taxes on the withdrawal.
Another option to consider for education saving goals is a Roth IRA. Savings in Roth IRA's can be withdrawn without penalty for educational expenses (Limits and rules apply to this. Speak to a CPA or tax professional)
Hope this helps, good luck!
Congrats! I am a father of two as well, so I know what a wonderful, joyous, and challenging time it can be. I have written on this topic in some detail, here is recent article that I think would help:
The 529 Plan is a great tool, but it is often overused. As my article mentions, maxing out your Roth IRA, if possible, is usually the best holistic strategy. For most people, retirement should come first. It is still early, but one advantage of using retirement accounts first is they are not used for most financial-aid calculations (FASFA – The Free Application for Student Financial Aid).
Also, before you dismiss 529 Plans, see if your state offers a tax deduction. It is hard to pass up the free money.
Other education-friendly, what I call dual-purpose accounts, are:
- I-Bonds (has some inflation protection)
- 529 Prepaid Tuition Plans (will match a specific schools inflation)
- ESA Account (low contribution limits but more flexible investments)
Other investments used:
- Muni Bonds
- Taxable Accounts
- Zero-Coupon Bonds
- TIPs (has some inflation protection potential)
- Has limited value for most, is oversold for education due to high sales commission
We also offer a very affordable online class on 529 Plans:
I also believe parents should start to think about college differently:
Mark Struthers CFA, CFP®
Congratulations on your new baby girl! And also on your forward thinking to start saving now for her educational future.
A 529 is good way to save since the monies grow tax free and if used for education, come out tax free. But you are correct, the returns are not always the best and there are the fees.
Why not do some of both! Save some monies in a 529 and some in an investment account. This way, if your daughter is brilliant and receives many offers for free higher education, you will not have all your eggs in one taxable, penalty driven basket.
If you have more children, the 529 makes more sense since the funds can be used for any child by just changing the beneficiary.
I hope this helps you decide.