How to financially plan for your child’s future and guarantee their success!
Every single parent in the world wants to do one main thing for their newborn baby: To give them the best possible life within their means and ensure their future success. In a more perfect world we should be able to say “money isn’t everything” and actually mean what we say. In today’s world that just simply isn’t the case.
The fact is, your child is going to cost money. You will need money to invest in your child’s future. Whether you want them to come out of college debt free, want to kickstart their savings or retirement plan, need an emergency fund, or simply just want to build them a nest egg that’s waiting for them when they reach adulthood, then now is the time to get started.
Actually, because of compound interest, the best time to get started was yesterday. Today is the second-best option. Before we do get started there’s just one main rule you need to follow regardless of which path(s) below you decide to take. That rule is to make sure you are taking care of yourself first.
You should not cut corners on your own health or wellbeing to contribute to a retirement fund for a newborn. You should also already have a family emergency fund set aside. Do you understand the one and only rule of the game? Great! Let’s get started
Compound Interest: The Millionaire’s Best Friend
The power of compound interest is simply amazing. A simple-interest investment will pay interest only on the original principal that you’ve invested. A compound-interest investment will pay interest on the principal plus any other interest you’ve already accumulated. This is one of the main factors that come into play whenever you hear a wealthy person say “Make your money work for you, not the other way around.”
Still a little confused about how it works? An example always helps! Historically, the investment methods we describe below earn an average of 7%-10% over a long period of time. Using the conservative rate of 7% interest, let’s take a look at Lauren and Brad.
When Lauren was a newborn her parents started saving and investing $200/month. By the time she hits 30 years old, they would have set aside $72,000 for her. Using the power of compound interest, the actual amount waiting for her is $260,844. So, yes, even though they set aside $72,000 over the course of 30 years, she now has over a quarter of a million dollars waiting to help her buy a new home, pay off her college debt, or to just keep investing into her retirement with.
Brad was 15 years old before his parents decided to start investing in his future for him. They were financially stable, but just didn’t think they needed to start early. They put $5,000 away immediately and then invested double what Lauren’s parents did. Over the course of 15 years his parents still invested the same $72,000 that Lauren’s parents did, but his nest egg had only grown to be just a little more than $129,000.
What’s the takeaway here? Compound interest needs time to grow. Lauren’s and Brad’s parents both invested the same amount, but she had more than double the final yield than he did.
Building Wealth: What Are The Best Options For New Parents?
When looking into building wealth for your new baby, the primary options fall into one of two categories: College Funds and Non-College Funds. The primary difference between the two options is right there in their respective names. College funds are used specifically to plan for a child’s educational expenses outside of primary schooling. Non-college funds exist to just help you financially plan for the child’s future in general, outside of college expenses.
You could use the funds from a non-college fund to pay for college, but a college-specific fund will give you more bang for your buck. Additionally, there may be penalties or taxes for withdrawing from some of the non-college funds too early on into the investing process.
A 529 Plan Is The Best Fund For Future College Costs
The average cost of college tuition has more than tripled over the last 3 decades and it shows no signs of slowing down anytime soon. This is probably why 74% of adults who have college degrees say they wish their parents or guardians had done more to help them prepare for the crippling debt that often comes with a college degree.
The U.S. Securities and Exchange Commission, which acts as a governing body over various kinds of investments and savings plans, regulates the state-run 529 plans. They essentially help make sure everybody is playing by the rules. Having the SEC here serves a dual purpose. First, it’s to make sure that 529 plans are only used for educational expenses. Second, it’s to ensure that college and universities are playing by the rules so that parents have a hassle-free experience with using 529 plans.
There are two types of 529 plans which we will go over in more detail below. First is a prepaid tuition plan and the other is an education savings plan. All 50 states, including the District of Columbia, offer at least one of these plans. Many offer both.
529 Prepaid Tuition Plan
If your sole focus is on college tuition, this may be the best type of 529 plan for you (if available in your state). With a prepaid tuition plan, you are able to purchase credits or units at the current price of tuition. So when your child is 18 and ready to go to college, you will be able to pay for their college at whatever tuition was nearly two decades before.
These plans are sponsored by local state governments and usually have requirements based around residency and which colleges the credits can be used at. If your child grows up and decides they want to go to college somewhere else across the country, then you may not be able to achieve the full value invested into the 529 prepaid tuition plan.
529 Education Savings Plan
For a more broad college savings plan that not only covers tuition, but also mandatory fees as well as room and board, an education savings plan may be the route for you. Although these are typically state sponsored as well, these are easier to be used for out-of-state college expenses. Though the specifics will vary from state to state and college to college.
In addition to college expenses, a 529 education savings plan can also be used to pay for elementary and secondary schooling. You’re able to use up to $10,000 per year from this plan to pay for any private, public, or religious elementary or secondary schooling. The only downside to this is that pulling money out so early on doesn’t give it as much potential to grow. These plans are structured more like a typical investment portfolio and need time to grow.
529 Savings Plans Fees & Expenses
States are allowed by the SEC to charge various fees on these plans. This may be application fees, annual maintenance fees, and even brokerage fees. If you make a withdrawal and use it for its intended purposes, education, then you will not be subject to any federal taxes on the accrued interest, and likely won’t have any state taxes as well.
If you withdraw the money and use it for something other than education, you will be looking at at least a 10% penalty from the IRS. This penalty is to discourage parents from using this fund for anything other than education. If your child gets a scholarship you can still use the 529 plan for other school-related expenses to avoid the 10% penalty. If your child decides not to go to college or drops out early, then you’re stuck paying the penalty when you withdraw the money.
Non-College Funds Are Great For Your Child’s Future
The primary focus for many parents is on their child’s future education. This primary focus is why we dedicated so much space to the 529 plans. But what if, as a parent, you want to invest in more than just their future education? Luckily there are numerous ways to financially plan for the future, and we’re going to go over some of the best options for new parents.
Invest In A Roth IRA
Want to know a great way to kick start your child’s retirement? Investing in a Roth IRA for your child is a wonderful way to enjoy the steady gains offered by long-term market holdings and to take full advantage of compound interest. You do not pay taxes on the growth of the account and, if your child waits until retirement to withdraw the funds, they won’t be subject to any taxes, fees, or penalties.
As a parent you will need to open up a custodial IRA. It’s quick and easy and can all be done online. Not every online brokerage firm offers custodial IRA accounts, but some of the big players like Charles Schwab and Fidelity do. The downsides kick in if you or your child have to withdraw any money before they hit retirement age. The taxes, penalties, and fees can get pretty crazy when you start dipping into your Roth IRA too early.
Open A Health Savings Account
Opening a health savings account for your child is a great way to plan for future or unforeseen medical expenses, while saving money at the same time. Either parent can open an HSA for their child, provided they provide at least 50% of the child’s care.
Depositing funds into an HSA helps you avoid paying federal and state taxes on that income. You can then use this money to cover medical expenses, like those that come from having a high deductible insurance plan. Using the funds in an HSA for anything other than qualified medical expenses will subject you to fines, fees, penalties, and/or taxes.
Set Up A Trust Fund
A trust fund involves three parties. First would be you, the parent, investing the money into the fund. The second party is whomever is managing and growing the fund. The third party is the beneficiary, your child. A trust fund is a great hands-off approach to invest in your child’s future.
You can set the fund to be paid out to your child at a certain age or in benchmarks along the way. Should something happen to you, your child will be taken care of in the future. There are numerous types of trusts available and all will vary based on your network, projected contributions, and the terms of the trust. The drawback for trust funds is the setup and management fees. These need to be set up by a trust attorney and can be pretty pricey in the beginning.
A brokerage account is a good option for parents that want a more hands-on approach to investing and saving. If your financial goals are more than 5 years away (which, with a new baby, they most certainly are) then this may be a route to consider. With a brokerage account you are able to purchase stocks, bonds, mutual funds, and other assets. The downside to a traditional brokerage account is that if you don’t know what you’re doing, you can lose a lot of money.
Brokerage accounts are a great way to avoid maximum contribution limits that come along with other retirement accounts like an IRA or 401k. While they require much more work from the contributor, the right choices can certainly pay off down the line.
By law, a minor cannot typically receive assets. As such, if you had plans to include any assets to your child in a will or estate OR, more likely the child has grandparents that are considering this, then an UTMA account may be the right move.
Like a trust, an UTMA account simply holds on to the assets until the minor is of legal age to receive them. The funds in an UTMA account can grow by being invested in stocks, bonds, ETFs, and mutual funds. These accounts can also hold life insurance policies for the beneficiary.
This is a great way to ensure your child is of legal age before receiving assets, but is only ideal for those that already have a decent inheritance ready and set aside.
Whole Life Insurance Policies
Yes, it’s possible to invest by taking out a life insurance policy for your child. With certain whole life policies, the insurance company takes a portion of your monthly premium and applies it to the policy’s cash value. This cash value is invested and, on average, enjoys a rate of about 4%
Nobody wants to think of the worst possible scenario with their child but having a life insurance policy for unforeseen events is a good idea. Having a whole life policy that grows and has a cash value that could be worth $500,000 by the time your child is in their 40’s is just a smart decision.
Post 9/11 GI Bills can be used to pay for a dependent’s college expenses. If your child is 18 and a high school graduate, they can have their schooling covered. The GI Bill will cover the maximum in-state tuition amount for your child, give them a monthly housing allowance, and a $1,000 annual stipend to cover other expenses.
Will Planning Ahead Affect My Child’s Chance At Scholarships or Financial Aid?
This is a common question but is hard to give a direct, one-size-fits-all answer. None of the 529 plans will affect your child’s chances of getting a scholarship. As we mentioned above, even if your child does get a scholarship, you can still likely use the 529 plan to pay for other college-related expenses.
Financial aid can be a bit tricky. Some of these plans will require disclosure when applying for financial aid. A trust fund is the only exception. If your child has money waiting in a trust then that does not need to be disclosed as assets when applying for financial aid. Many of the other specifics should be discussed with a financial planner, attorney, or someone in the financial aid office to ensure you get an answer that caters to you and your child’s specific situation.
Be Smart With Your Child’s Education & Future
We know not everyone has extra money to invest in an IRA, or to lock up in a trust right now. We know not every child has parents or grandparents that are going to purchase 529 credits for them. You can still be smart and ensure your child gets a good education without incurring a lot of debt.
Always try to apply for grants and scholarships, regardless of your financial situation.
Talk to the financial aid representatives, they know what they’re doing.
The most expensive school is not always the best school.
Getting credits from an accredited school is what matters the most. Your child should consider doing their freshman and sophomore years at a cheaper school or community college.
Keep applying for scholarships while you’re in school. Often it can be much easier to get a scholarship once you have a year or two of schooling under your belt.
We know that planning ahead for your child’s future is important for you, and we commend you for doing the research on which route is best to take. Because every single family has a different financial situation, it’s hard to give a catch-all answer that works best. We hope at the very least that we’ve given you enough information to at least point you in the right direction for how to plan for your child’s future.
Planning For A Baby Financially Series:
Pre Baby Financial Planning: When is the Right Time to Have a Baby Financially ?
The Best Money Saving Tips For New Parents
The Top 7 Websites To Use For Cash Back Shopping
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