Kiddie Savings

[kork13]

Awesome news — My wife & I will be adding two feet to our family in June! (a.k.a., DW is pregnant!). As a SA’er, one of my current thoughts is how best to save for Thing 1’s future (a la Dr. Seuss, Thing 1=baby, sans a proper name as of yet). As I understand it, here are our options:

529 Plan
Coverdell ESA
UTMA/UGMA (what’s the difference, if any?)
Custodial investment account
Treasury Bonds (meh… lackluster thanks to low rates)
Custodial savings account (again, miserable rates)
…..Anything else?

I’m leaning toward either 529 (with some reservations), UTMA/UGMA, or just using a basic custodial investment account. I don’t know much about ESA’s or UTMA/UGMA's. We’re basically trying to figure out what our best option would be. We’re happy to provide for Thing 1’s future college expenses (529 is probably an unqualified winner in this case), but we also would prefer to have the flexibility to be able to use that money for other needs, if college isn’t Thing 1’s chosen route (for example, Thing 1 decides to be an electrician & needs to attend a trade school instead of college), or if scholarships preclude its use (I got a full-ride scholarship, and my college savings went unused…instead, they went toward my younger brother’s private college tuition).

A few questions we have:
1) First and foremost, what type of account would you recommend, and why?
2) A big concern I see alot about using UTMA/UGMA or custodial accounts is that those assets are held in the child’s name, and could disqualify the child from financial aid. What sort of financial aid does that include? My parents both had professional careers, and our household income & assets was relatively high (easily “upper-middle class”). My brothers and I never qualified for any financial aid for college, and I foresee my own family/children being in the same situation. So should this really be a concern for us?
3) If we went with a 529 plan, how much does the state we choose matter? Any recommendations on what state would work best for us? If it matters, I use Vanguard for all of our investments, and would prefer to keep everything inside the Vanguard world if possible (for simplicity's sake).
4) Any other advice/recommendations are happily and gratefully accepted.

BTW, brief background: my wife (29) and I (28) currently live in Oklahoma, but are both active duty military (US Air Force) so we move around ALOT. Likely in the 15% federal tax bracket this year (due to a variety of military tax benefits), but I’m expecting to jump into 25% anytime in the next few years. We don’t pay state taxes (military pay is not taxed by state) and our plan is for at least one (possibly both) of us to stay in for a full 20-25 year military career. We will also have Post-9/11 GI Bill benefits available to us that could be transferred to children in the future. Combined income ~$145k/yr, current assets are 2 houses we both purchased before meeting/getting married (total value: $268k), retirement savings $152k, $92k other savings/investments (including full EF), and only debt is $203k between both mortgages.

[Like2Plan]

kork13,
That is awesome news! Congratulations on your upcoming addition.

Transferring the GI bill to your child is an awesome benefit. I believe that some colleges have an agreement to charge the in state tuition rate for folks using the GI bill even if they are not residents of that state. Question though, is there a risk that this option will change (or time out) over the next 18 years such that your young one won't be able to take advantage of it? Having this benefit would make me reluctant to put a lot of money into a 529 plan. Were you thinking of saving additional money to cover potential private tuition costs or graduate school expenses?


You have to be careful about the UTMA/UGMA accounts because of the kiddie tax. The earnings above a certain threshold are taxed at the parent's rate--this is through age 22 if your child is attending college and your dependent. So, to my way of thinking--maybe it's not such a good idea to put a large amount of assets in the child's name. It's probably better to hold the bulk of assets in your name and transfer them to your child if/when they are needed (Assets in your name are more favorable than in your child's name for purposes of determining financial aid--though it doesn't sound like that will be an issue for you).

[disneysteve]

Congratulations! That's exciting news.

As with most financial decisions, the answer isn't as easy as "which one should I pick?" You will likely want/need more than one type of account.

Obviously, 529 and Coverdell are college savings accounts. You certainly want at least one of those.

But you probably also want a non-college savings account of some sort. Why? Because there will be money that you want to put away that isn't intended for college. Plus, once Thing 1 gets old enough to understand money, he/she will also want an account for birthday or holiday presents, and later for babysitting or lawn mowing or lemonade stand earnings (at which point you'll also want to talk about opening a Roth).

What did we do? We opened a custodial savings account at our bank. Yes, it earned nothing, but it gave a place to park money and get DD initiated into the banking world. We also started a 529 for her.

As for 529s, the main reason to use the one from your home state is to capture a tax deduction if they offer one. In your case, since you move around a lot, that's much less of a draw. In that case, I'd go with the best plan which is likely one of the ones administered by Vanguard. We are in the NY state plan. I believe Utah is also well-rated. Go to savingforcollege.com to do your research on the options.

[snafu]

Congratulations, marvelous news! Best to Mrs 'Kork'

[Like2Plan]

I wanted to add-- Congress changed the kiddie tax rules quite a bit while our DS was growing up. When we started out, they didn't have 529's and the majority of the college savings went into savings bonds (with deferred earnings) in DS's name. The original plan was to cash the bonds after age 14 and use the proceeds for college. Congress changed the kiddie tax age to 18 and then to 23 which pretty much ruled out using the bonds in DS's name for college. By that time they had the 529 program so, we started cashing the bonds keeping the earnings below the threshold where the kiddie tax would kick in and we put the proceeds into his 529 savings plan.

We also invested in individual growth stocks for him to hedge our bets (in case he wanted to go to a private college). We selected individual growth stocks so he didn't get dividends and we could control capital gains to some extent (vs a mutual fund which I couldn't predict when/how much the capital gains would be). This turned out to be something of an accounting nightmare over time, though (we bought direct reinvested the dividends). Lots and lots of statements to keep track of the cost basis, etc (not as much of a big deal now that the brokerage/company has to keep track of the cost basis as well). We encouraged him to liquidate his stocks after graduation. It was nice for him to have some resources to help him move and get him started in his new career.

Here is an article on the Kiddie Tax from TurboTax:
What is the Kiddie Tax and Do I Have to Pay It?

This from the TurboTax article:

"There are some strategies that might minimize your exposure to the Kiddie Tax.

One way is to generate gains on a regular basis that maximize the usage of the $2,000 threshold.

This means taking capital gains each year by selling stocks with gains each year and then buying the stock back, creating a taxable event each year. The transaction also allows the cost basis on the investment to increase while using up some or all of the yearly $2,000 threshold."

and the topic from the IRS web site.
Topic 553 - Tax on a Child's Investment Income (Kiddie Tax)

[TBH]

I just want to say I think it's adorable that you basically found your female equivalent, professional and financially, Kork.

[corn18]

Start contributing to a Roth IRA at whatever age you feel comfortable paying them. If they have chores, pay them for doing them. $100 a month would seem reasonable for an 8 year old (for the purpose of this exercise). Raise that 10% / year and by the time they are 18, they will have $16,295 in a tax free retirement account. Let it grow @ 7% for the next 50 years and they will have a tidy $480,000 nest egg without saving another dime.