Investing for Baby: Lower Risk/Lower Return

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Investing for Baby - Lower Risk
Lower Risk/Lower Return
The safer the investment, the more peace of mind you have, but the less money you earn. If you're a low-risk investor, you won't yield that 9% interest cited above, but you will have some interest accrual and peace of mind.

Savings Bonds We've all got some in the safe deposit box. Your child is bound to receive them as gifts. They are a solid investment, but they may not be the way to save for college. The time lock-in is extensive.

Lowest risk options are traditional savings accounts, money market accounts, and Certificates of Deposit (CD). A traditional savings account needs no explanation. Are you familiar with money market accounts? They are similar to traditional accounts in that you make deposits, but you can access the money via checks as well as ATM withdrawals (not that you should be withdrawing from an account dedicated to college savings).The bank pools the investment of many account holders to use as loan money for car purchases and home mortgages.

Because these loans are made with physical collateral, the bank has a low risk.

Because you should only be investing at an FDIC insured bank.

CD's are similar in design, with the exception that there are time restraints on the investment. You commit your money for a set period of time, allowing the bank long term use of your funds for their own investments. Because you are allowing that long-term use, you are expected to honor the time requirement. That is why the interest is higher than other bank accounts. If you need to access your funds early, there are financial penalties. CD's make sense when you start saving early in your child's life. Most families open these accounts in the child's name, with either parent as the trust holder. This is better for tax purposes. However, the accounts legally belong to the child, so once she turns eighteen the funds are hers to use as she pleases.

These safe investments are comfortable for most people. Not much opportunity for large growth, but these accounts are better than saving money in a piggy bank or under the mattress. While these accounts may have been the way your parents saved for your education, they're not ideal in today's financial times.

CD's have a higher return. Your money is locked in for as few as six months to as long as five years. When it matures, you may access the funds or roll them over into another CD so your money can earn more for your child's future. In early 2006, CD interest rates ranged from 4% to close to 6% depending on the amount invested and the agreed investment time. Interest you earn on these accounts may be taxed. Remember: make sure any bank you use is FDIC insured.

Education IRA (Coverdell College Savings Account) This is a tax free way to save toward education. The education IRA, known as the Coverdell College Savings Account, uses pretax dollars (up to $2,000 a year) for an interest earning account. The beauty of these accounts is that even the earnings are tax free, as long as the beneficiary (your child in this case) uses the funds for educational expenses before the age of thirty. Anyone may invest in these type of accounts on behalf of your child, but the total investment is capped at $2,000 a year. You can open an education IRA at your bank of choice.

Section 529 College Savings Plan These are called Future Scholar accounts. 529s are state-regulated education savings plans which have tax advantages both federally and within your state. Earnings grow tax free. Each state has different guidelines which govern the accounts. Check with your financial advisor to learn about the guidelines in your state. With these college savings plans, an adult opens the account and actually owns it. The owner can be a parent, grandparent, any interested adult. The future scholar (child) is named as beneficiary. Should the child receive a scholarship or decide not to go to college, the funds remain the property of the parent or grandparent who opened the account.

Because the funds are intended for education, there will be a large penalty if the money is withdrawn for other purposes. However, the beneficiary can be changed at any time, so if your child opts out of college, you can name a sibling or other family member beneficiary and use the funds for that beneficiary's education. There is no age limit, as there is with a Coverdell. There is a maximum contribution limit, which varies from state to state.

With the 529 College Savings Plan, a number of U.S. states have recently designed prepaid tuition programs. They are intended to be used to pay in-state tuition, but can be applied to out of state and private colleges. Families lock in tuition rates and invest in a prepaid tuition plan. The same rules of transferability apply if the beneficiary does not attend college or receives a scholarship.

Both types of 529 accounts grow tax free. They are excellent plans for slowly and steadily building that college savings.