Wwrd-a Practical Solution For Educating Your Children


by Ron Piner, CPA - Date: 2007-06-25 - Word Count: 808 Share This!

Practical financial advice is what we all should desire. The WWRD series is designed to provide real life circumstances along with real life, practical solutions, to these circumstances. Here is the first set of circumstances in the WWRD series.

Suppose there is a middle income family with two children. Husband and wife both work and make contributions to their respective 401K plans. Their goal is to begin saving for the college education of their two lovely daughters. One of the daughters is quite smart; the other is very athletic and is good at every sport she attempts. Father recently got a raise in compensation at work and is thinking of what to do with the extra money. The family does have some savings outside of the retirement plan but would like to have more in case of an emergency. What would be your advice to this family in order for their financial goals to be met?

The first order of business is to identify all of the issues at hand. This family is saving for retirement for the parents, it is taking care of children, it is building a portfolio outside of the retirement plan (more attention should be given to this area), and the family is deciding how best to provide for the education of its children. Does this study case sound familiar to anyone? Before I get started on the solution to this situation, I would like to first mention life insurance. Is there enough protection against one ore both of the parents passing away? There should be enough insurance to provide for income replacement if both parents pass. This could mean having each parent purchase significant life insurance to protect family assets. A rule of thumb might be to assume a 6% return on investments and then calculate how much insurance will be needed to generate the same income provided by each working parent. For example, if one parent makes $120,000 per year, $2,000,000 in coverage will be needed to provide for income replacement. This insurance, in my view, can be obtained through a term policy that would expire at some point after the kids are projected to graduate college, say at age 24. Remember, life insurance is a hedge against living and there is coverage that is needed. We do not want to get more coverage than we actually need. Enough said on this portion of the discussion.

Let's get back to our case study involving this family's desire to provide for a college education. I will bet that many of you are already saying that the solution is simple, just get a 529 plan. I am going to stop you here and ask that you think of this investment strategy. Putting money into a 529 plan will be similar to you putting money into a retirement plan. The investment strategy will be the same. The contributions made will have a given purpose and will be invested with a strategy that will protect this interest. Doesn't this sound like the 401K? It sure does to me. Let's remember that this family wants to build on its emergency funds. In addition, it's important to consider that the kids may not want to go to school, could get a scholarship of some sort, or could make some other arrangement to fund college. Mom and Dad should consider building the emergency funds needed and building a portfolio outside of the retirement plan. Tax exempt bonds and large cap stocks can be used in addition to savings to build the emergency fund and increase the portfolio. The argument many will make is that the 529 plan grow tax free. This is true. I will submit to you that a portfolio can grow outside of the 529 on a tax free basis if one knows how to master capital gains and losses netting (see my article on capital gains and losses as well as portfolio management). If this is done effectively, the portfolio can be built to accommodate all needs. It can build for education, it can provide for retirement, and it can be used for most anything. A variety of investments will be available outside of the 529 plan. These investments will take advantage of income tax attributes available to one's portfolio (capital losses, suspended passive losses) and if managed properly, can gain similar tax free growth like the 529 plan.

As always, it is important to be flexible when managing a portfolio inside and outside of the retirement plan. The 529 can make perfect sense in the right set of facts and circumstances. If one is very wealthy, or the grandparents want to get involved in saving for college, the 529 plan could be the perfect venue. Match a financial strategy with the facts and circumstances that you have.

Ron Piner, CPA
Host of "Better Business"
Saturday Mornings at 10ET
ON WBIS AM 1190
www.wbis1190.com
www.mwibonline.com

Related Tags: education, investing, income taxes, college education, income tax help, ron piner, 529 plans, free tax help, educating children, taxes tax help

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