which college savings plan whould i get?

Question

Hello, my sister is due to have a baby in 2 weeks and we live in nyc, she was wondering which is the best way to save for a college for her new born.
she has mentioned a few options like a ny state sponsedred 529 plan.

and also mentioned ING direct which is a personal savings account with a apy of 4.00 percent.

and then you have a roth ira that she can open up for herself and use the savings from that plan to pay for her childs school.

what are the pros and cons of these and also which will yeild the most bang for the money, and also less going towards taxes and more towards me.

i am also open to hear any other options you might have from other savings. THANK YOU SO MUCH

oh i also forgot to mention that she has a 401k plan at work, is that ok to use instead of the roth ira or should she get the roth ontop of the 401k plan she already has

Answer 1

I've investigated this quite a bit, as I was interested too.

If your sister is sure that she will have someone to spend that education money on, like her kid, herself, or another family member, a 529 is the way to go. 529s let you put a lot of money in, and all the earnings are tax free if spent on education. The money is not tied to a specific person, so the beneficiary can be almost anyone.

I'm linking to Clark Howard's (a radio consumer advocate) list of good 529 plans. The New York plan gets top billing. The best way is to buy these through the state program, not some commissioned broker. The link I gave has links to each state program.

Here's the problem with 529's. If your child doesn't go to college or some other eligible education option, and you've got no one else to give the money to for education, or you don't want to, there is a HEAVY penalty on the earnings if you don't spend it on education. First you pay a 10% Federal Penalty, probably a state penalty, 2 1/2% in my case, and then normal income tax on all those earnings, on top of your normal income. So you'll pay at least a 10% plus pay taxes at the high end of your bracket. This is the reason I have not picked a 529. I think a lot of people are in for a rude shock when their kid doesn't go to college and they want to then use it themselves or give it to their kid for other purposes.

Using her Roth IRA is an option. The beauty of a Roth is that you can pull out your contributions tax free for any reason at any time. Only the contributions mind you, not the earnings. However if the kid doesn't go to college, the money is there for your retirement, fully tax free after age 59 1/2.

Another option is a tax managed mutual fund, where the fund is managed to deliberately reduce taxes.

I believe Savings bonds have a provision where if spent on certain eligible education expenses, the earnings are tax free, but you'll want to double check me on that one.

One last thing. Your sister should ALWAYS save for her retirement first. It sounds selfish, I know. But kids have many options for college education. There are scholerships, grants, student loans, GI Bill, part-time job,etc. None of that exists for retirees. If she doesn't fund her retirement first, no one will be there to offer her retiree loans or scholarships to help. This also jives nicely with the Roth IRA option. Save for your retirement in the Roth and other retirement vehicles, and if you are on track for a good retirement, you can pull some out of the Roth IRA to help with the kid's education.

UPDATE - Perfect. The 401k should be used as your sister's main retirement plan. The Roth can be used in addition, for either purpose.

I'm afraid I have to disagree with Jeff D. A no cost bank investment officer or financial planner usually gets commissions on investments they sell you. That's how they get paid. Thus, while they may be selling you the best investment for you, they may also turn around and sell you the best investment for them, comission wise. If you want financial planning advice, go to a fee only financial planner.

Answer 2

I live in Canada but I'm sure my suggetion applies to the USA. First off, I would make an appointment with your bank investment officer (financial planner) it should not cost you a penny for this info. Then I would contact a couple more financial planners for the answer. None of this info should cost you money. You may find that investing in 2 or 3 different methods will be the best bet over time because you do not know how your money will flow (hopefully increase) over time giving you more options to increase your return.