Expert: Gina Boykin - 6/17/2009

Question
Hello and thank you for your time. Our son is 1 year old and we want to start saving money for him when he graduates high school, hopefully for college. Thus far we have saved $700 dollars for him and placed it in a youth savings account that is earning next to zero for interest. How can we continue to save money for him that earns more return? It needs to be risk free, no stock market or mutual funds. I would also like to have the returns tax sheltered if possible. My thoughts are to spread his money across CD's, money market accounts, and maybe in some gold/silver coins yet these carry a risk so not sure. If we go the CD's and money market accounts, is the interest earned under his name/SS# therefore not likely to reach the income threshold for even filing a return and in a roundabout way tax sheltered?

Thank you,

Joe

Answer
Putting money in CDs or money market accounts would either have to be in your name, or in a UTMA/UGMA account (Which is a custodial account) in both your name and the child's name.  In your name, everything is taxable, but you keep all flexibility on what to do with the money later.  The UTMA/UGMA earnings are taxable as well, but as long as the child doesn't have significant income, there will be no tax.  Once the child becomes of age (this age varies by state#, he will be the complete owner of the account, which means he could use it for anything he wants #which is good if he ends up not going to college#.  The disadvantage to these types of accounts is that since the money is really his, it is treated differently for financial aid and could result in less assistance.  If you kept the CDs in your own name, you would not have this issue.

Another alternative for saving is prepaid tuition.  With these plans, you can lock in today's college prices and you won't have to worry years from now about inflation causing the tuition to skyrocket. Since historically, college prices have been rising an average of 6 percent, that really is like earning a similar rate on your money.  Also, there is really no risk of losing your principal #which is your concern with stocks and mutual funds#.  The primary negative aspect is that you can only use the money for schools in the plan.  Also, the money can only be used for tuition #not room and board or books), so you'd have to find another way to save for these things, or expect that to be covered by financial aid or loans.

There is no rule that says you have to save for college through one type of account.  The only way to get a higher return is going to take some risk, and with the young age of your child, you have plenty of time to ride out the market ups and downs.  Think about spreading your money among different types of accounts.  You could put 1/4 of your money in stocks or funds and the other 3/4 in low-risk accounts.  You could chose the prepaid tuition, and save for room and board through a 529 or CDs. Remember, there are no absolutes.