Guide to the Most Popular Ways to Save for College

Guide to the Most Popular Ways to Save for College

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The information below shows the most common savings techniques used by those saving for college according to a survey done by Fannie Mae and some helpful information about each of them.

Setting money aside for your child's education can be an effective way to pay for sizable tuition, room and board, and other miscellaneous education expenses. According to the College Board, the average price for a private college for the 2013-2014 school year was $31,231; the cost for state residents are public colleges $9,139; the cost for out-of-state students at public colleges $22,958.

Because of the compounding value of money, the earlier you start saving for your child's education, the more of a chance the money has to grow.  It's important to keep in mind that in almost all cases, if the child or parent wants to maximize financial aid, any money saved should be done in the parents' or grandparents' names.

The information below shows the most common savings techniques used by those savings for college according to a survey done by Fannie Mae and some helpful information about each of them.

Savings Accounts

Used by 45% of those saving.

FDIC Insured accounts offered by banks and credit unions.

Pros:

  • Easy to open
  • Money is FDIC insured.
  • Some modest interest on high yield accounts.
  • Money very liquid and easy to withdraw.

Cons:

  • Interest is relatively low right now.
  • Money does not grow that quickly.
  • Income is taxable.

Who Is this For:

Students who are two or three years away from college and cannot afford to lose money in the stock market but want to earn some  interest on their savings.

How to Open

You can open a savings account at a bank or credit union. BestCashCow can help you find the best rate from a local bank or an online bank.

 

529 College Savings Plans

(Used by 29% of those saving)

Education savings plan set up by state or educational institution that grow Federal tax-free and can be distributed tax-free.  The plan may also offer some state tax benefits. Generally, each state has its own 529 plan.

Pros:

  • Income grows Federal tax-free.
  • No taxes on distribution as long as used for qualifying educational purpose.
  • Donor retains control of funds.
  • Low maintenance as the plan takes care of managing the portfolio.
  • Up to $300,000 per beneficiary allowed in most state plans.

Cons:

  • You must use the money for college or there is a 10% penalty on withdrawal.
  • Fees can be higher than no-load mutual funds.
  • 529 performance is not guaranteed.
  • The funds can and have lost money.

Who this is for:

529 Plans are good for parents of younger children who have 5+ years to go before they attend college. This allows them to ride out any downturn in the market. The plans are also good for parents who want to take advantage of the tax advantaged nature of the plans.

How to Open:

You can open a 529 Plan through a brokerage.

 

Checking Accounts

(Used by 24% of those saving.)

A deposit account at a bank or credit union that allows the user to withdraw money using checks, debit cards, ATMs, or other electronic means. Usually does not pay high interest.

Pros:

  • Easy to open
  • Money is FDIC insured.
  • Some modest interest on high yield checking accounts or online checking accounts.
  • Money very liquid and easy to withdraw.

Cons:

  • Interest is relatively low right now. Money does not grow that quickly.
  • Income is taxable.

Who This is For:

Students who are two or three years away from college and cannot afford to lose money in the stock market but want to earn some  interest on their savings.

How to Open:

You can open a checking account at a bank or credit union.

Find the best checking account rate.

 

Investments

(Used by 20% of those saving)

Stocks, bonds, and mutual funds not included 529 Plans or 401K plans.

Pros:

  • Total flexibility in choosing  investment options.
  • May have higher return than bank-based investment accounts.
  • Money can be withdrawn and used for any purpose.

Cons:

  • Money is taxable.
  • Investments can lose value.

Who this is for:

For students and parents who want a higher rate of return than what is provided by a bank account but might also use the money for purposes other than college expenses.

How to Open:

A brokerage account allows you to deposit money and invest. View our list of brokerage accounts.

 

Retirement Accounts

(Used by 18% of those saving)

Retirement plans such as Roth IRAs, 401K plans, and regular IRAs.

Pros:

  • Roth IRA plans allow the money to be withdrawn penalty and tax free after the age of 59 1/2.
  • Other IRA plans allow penalty free withdrawal if the money is used for education, but taxes must be paid on the earnings.
  • If you borrow from a 401K, the money is not counted on the FAFSA.

Cons:

  • Money is taxable.
  • Investments can lose value.

Who this is for:

For students and parents who want a higher rate of return than what is provided by a bank account but might also use the money for purposes other than college expenses.

How to Open:

Employee sponsored plans can be opened at work. Non-employee plans can be opened and funded via a brokerage company or financial company.

 

Certificates of Deposit

(Used by 16% of those saving)

FDIC insured instruments in which the depositor agrees to leave the money in the bank for a set period  of time in return for a set rate of interest over that period.

Pros:

  • Safe. Certificates of Deposit from FDIC insured banks are considered to be a very safe investment.
  • Generally higher interest than a savings or checking account.

Cons:

  • The money is not very liquid during the term of the CD ( a user can break the CD and withdraw money by incurring a penalty.)
  • Current interest rates are low by historical standards.
  • Income from CDs is taxed.

Who this is for:

Students who are two or three years away from college and cannot afford to lose money in the stock market but want to earn some  interest on their savings. Or, parents who do not want to take the risk of investing education money in the stock market.

How to Open:

You can open a CD at a bank or credit union. Find the best rate from a local bank or an online bank.

 

US Savings Bonds

(Used by 15% of those saving)

Bonds issues by the Federal government that pay interest.

Pros:

  • Savings bonds are extremely safe, backed  by the full credit of the U.S. government.
  • Income from savings bonds can be excluded if used to pay for college (note this is not available to higher earners. Read more).
  • If bonds are in the parent's name, it will have a low impact on financial aid eligibility.

Cons:

  • Interest on savings bonds is low, even compared to CDs and savings accounts.
  • For higher-income families, savings bond  income is Federal, but not state taxable.
  • Savings bonds must be held for at least 5 years or a penalty of the last three months of interest.

Who this is for:

With current interest rates, there is no reason for anyone to use Savings Bonds as a college savings vehicle.

How to Open:

Savings Bonds can be purchased directly from the US Treasury website.

 

Coverdell Accounts

(Used by 13% of those saving)

Tax-advantaged accounts similar to 529 plans that help saver for education expenses. The money can be used for K-8, high school, or college.

Pros:

  • Money can be used for elementary, high school, or college expenses.
  • Money grows tax-free.
  • Investments are self-directed allowing more flexibility in choosing options.
  • Money in the child's
  • If funds are in the parent's name, funds will have a low financial aid impact.

Cons:

  • There is a maximum contribution limit of $2,000 per student per year.
  • Income  limit of $95-$110,000 for single tax-payer and $190,000 - $220,000 for married couple filing jointly.
  • If the account is in the child's name, fund in the account will have a high impact on financial aid treatment.

Who is this for:

The Coverdell plan is for parents who might want to use the funds for private elementary, high school, or college, who like to control what the money is invested in, and who earn below the max-income guidelines.

How to Open:

Many financial services companies offer Coverdell Accounts.

 

 


Time to Get Serious About The Bond Bubble Bursting

Time to Get Serious About The Bond Bubble Bursting

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As 10 year bond yields have gone from 1.80% to 2.15% over the last month, Janet Yellen, Bill Gross, Jeffrey Gundlach, Scott Mather and many others have made statements indicating that the bond bubble may finally be ready to burst. It is time to get serious about the potential consequences of the bond bubble bursting.

In 2013, the 10-year bond went to a 3.05% yield briefly.   Many traders who were heavily long fixed income got really hurt when this happened, but the general public was spared from the consequences of a end of cheap money as cash from global markets began pouring into the US to drive rates back down.

At this point, many experts are indicating that the current 10 year yields are well below where they should be at this point in the economic cycle and they should begin to move off of the unnatural post-recession lows that we have seen for the last 6 years in anticipation of a change in Fed policy.  Janet Yellen, herself, has indicated that the cycle of unnaturally low interest rates needs to come to an end and that when it does long term rates may spike higher.  High profile observers – including Bill Gross, Jeffrey Gundlach and Scott Mather - have all been quoted in mainstream financial media over the last several days as suggesting that as the Fed begins to raise rates, long bonds will go up more quickly.   Even if the rise in the Fed Funds rate is extremely slow and deliberate, 10 year rates will wind up back to 4% or 5% over the next year or two.

This is a good time to confront reality.  If 10 year rates were to go back to 4 or 5% (or 6 or 7%), the discounted present value of that cash produced by instruments that you may hold will become less valuable (i.e., will become discounted at a higher rate).   The value of long-term municipal bonds will fall.  Corporate bond spreads will widen, not narrow, and the value of corporate (high grade and high yield) bonds that you hold will fall sharply.  The value of your emerging market bond and EM bond funds will fall dramatically, as will the value of any preferred stock that you may hold (including Public Storage’s preferred stock that I have previously recommended). 

I do not pretend to be a real estate or a stock market expert, but it would seem that your real estate and equities will impacted as well.  Real estate values in frothy markets like New York, San Francisco and Miami may fall from their bubble levels as mortgage rates rise.  Stocks – including Blue Chip stocks such as Disney, Procter & Gamble, McDonalds and Coke – that trade at extremely high, above-market multiples of earnings against anemic growth will see a sharp correction.   (The broader market however may move higher and fast growing, dynamic growth stocks with large cash stockpiles, very low PE ratios, and PEG ratios below 1 such as Apple and Gilead should be virtually unaffected and continue to move dramatically higher).

This is probably not the time to sell your home or exit the stock market.  But, it is a good time to think about some key things you can do to protect yourself from a rise in interest rates.

1.  Think about raising cash, selling your bonds (except for those nearing maturity), bond funds, bond like instruments, and stocks with unsustainable valuations.  Earning 1% a year over the next two years is a better outcome than losing 20% or more of your principal over that period.    If you still aren’t earning 1% on savings, see this list of the highest yielding savings accounts.

2.  Put money in CDs.  You can earn 2.25% on a 5 year CD from Synchrony or Barclay’s Bank that allows only a six month interest penalty for early withdrawal.  As this article discusses, that is a pretty reasonable risk-reward scenario.  Alternatively, put your money in a CD that offers a better rate than cash and provides the opportunity to raise your rate should rates rise.  CIT Bank’s family of RampUp CDs are not only among the highest yielding CDs, but offer this flexibility.

3.   Invest in structured notes that are geared to pay out more money as interest rates rise.  I have written extensively about these notes on BestCashCow.  My favorite notes are those that pay a multiple of the spread between the 2 year and the 30 year Treasury (or Constant Maturity Swap) rates.  While this notes usually require assuming the credit of a bank, such as Chase or Morgan Stanley, they are currently paying around 6% and would move to paying their maximum distribution amounts of 9% to 10% should the interest rate spread widen.   These notes may not always be offered in primary markets and can be difficult to find in secondary markets.  Read my earlier articles on these notes here or here.

Happy investing.      


Acorns Investing App Makes It Easy to Put Money Into the Market

Acorns Investing App Makes It Easy to Put Money Into the Market

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I recently came across a new investment app that has become popular over the past year. The app, called Acorns provides a tool that rounds-up a user's debit or credit card purchases and then deposits that money into a portfolio comprised of ETF funds.

I recently came across a new investment app that has become popular over the past year. The app, called Acorns provides a tool that rounds-up a user's debit or credit card purchases and then deposits that money into a portfolio comprised of ETF funds. As an example, if you purchased a $2.67 cup of coffee, Acorns would take an additional $.33 cents out of your account to round the total purchase up to $3.00. The $.33 would then be put into an investment account.

The investment accounts that they provide are a basket of ETF funds that are selected by "a group of engineers mathematicians, and a Nobel-prize winning economist..." The entire investing process is automated, meaning the algorithms automatically choose a diversified basket of ETF funds and rebalance the portfolio when it is deemed necessary. Because it is all automated, the fees are relatively low. Fees are $1 per month for accounts with less than $5,000 or .25%/year for accounts with $5,000 or more in them. This is separate from any fees charged by the ETFs that Acorn chooses, but ETF fees are generally as low as you are going to get.

While the round-up funding method is the one that is most discussed, users can also choose to simply transfer a fixed amount of money into their investment account.

I was a bit skeptical at first but after I watched the video embedded below, I think that they are on to something. If a young person, or even an older person dips their toe into the water by investing round-ups, that removes many of the barriers to getting started as an investor. After all, what generally stops someone from investing is fear and a lack of what to do: how much should I invest, where should I invest, how much should I put in which funds, etc. But Acorns makes it easy for someone to start putting money to work and once this process starts it seems like an easy path to become a life-long saver and investor.

I also agree with one other point mentioned in the video. Financial educators can yell until they are blue in the face that people should start investing, but getting someone to take that first-step is the best way to get introduce them to the practice of savings and investing. Once someone has money in the market, they are much more likely to pay attention and be open to education.

My One Concern

The one concern I have, the reason I haven't signed up yet is security. Acorns is probably safe and I'm sure they have done everything in their power to secure it, but I've seen too many instances where "secure" systems were breached and social security numbers and other sensitive data was stolen. I'm sure Acorns is no less secure than any other major bank or brokerage but still, I feel nervous providing my information over a phone app.

Still, if I can get over this concern, Acorns is something I would be interested in checking out.