For parents or grandparents, there are few things in life more important than funding for a loved one’s college education.
Throughout the years, folks have selected mutual funds as the primary vehicle when saving for college costs. Although there are many variations of mutual fund based plans-from the traditional brokerage account to the newer 529 plans; there is even a Education IRA that is popular as well. The latter plans were developed so that a person could save for college, using after tax money and based upon the underlying mutual funds, the person could enjoy tax-deferred savings
A lot of the financial press has been dedicated to promoting the virtues of these savings vehicles from the standpoint that college costs are rising faster than inflation and a family needs to accelerate their savings using these types of plans. However, hidden in the fine print was the unfortunate realization that these types of vehicles could, in fact, lose money! How many families were shocked when their hard-earned money evaporated when the stock market declined 35% decline in the S&P 500 Index from 2000-2002-only to have it go down another 46% decline from October 2007- October 2008?
The problem with a lot of college planning techniques is that money is typically invested in mutual funds inside these plans and those funds are 100% at risk to loss due to stock market downturns thereby subjecting the invested money to the 46% and 35% declines listed above.
So if you can lose money in mutual funds, how do you save for college? That’s a good question and the simple answer is that “it depends”. This is a simple answer that many quality financial advisors use to determine the right solution for your needs. It is also a way to do a proper job for any potential investor-thereby not throwing the “latest and greatest” product or plan at a potential client!
Generally speaking you could have put money into a tin can for the last 18 years and had more money than investing in the market! Hmmm, let’s say that again-more money in a tin can than the market-whatever do you mean? First off, you need to start with some kind of deposit, let’s say $50,000 or the amount necessary to accumulate $50,000 in 18-years which in this case would be $231.48 per month (assumes no interest or taxes paid). Now, let’s think about your own situation, if you had put away that money-knowing full well that it’s not earning a penny-would you be happy with that? “It depends”. There he goes again with that simple phrase! If you started with $50,000 and because of the market it is now worth $25,000-then the answer is an emphatic YES! If you had $50,002.50-maybe. If it was worth $101,290.83-definitely NO! What about $79,938.88, again definitely NO!
But, how would you guaranteetin can-right? Correct! These numbers represent investing $231.48 per month for 18-years at an interest rate of 4% or depositing $50,000 into an account that pays 4% for 18-years. But where could one find a steady 4% interest rate? One place is a fixed, deferred annuity. A fixed annuity is a safe savings vehicle brought about by an insurance company. Your money earns a fixed interest rate declared by the insurance company, using not less than 3% annually. Some annuities pay a multi-year guaranteed rate of interest, which can be 4% or higher depending on the term of the plan.
Now are you ready for the good part? Wait, you are telling me that having invested $50,000 18-years ago is now worth $101,290 is not the good part? Yes. It is a very good part, but let’s get back to our original discussion about college savings. If you are a parent whose son or daughter is approaching college and much like your peer group, you have saved money in (my opinion) the wrong places-ie. Mutual funds, you are now going to be faced with another problem: Financial Aid eligibility! Without getting too much into detail, all the money that you’ve invested for their college may now go against you for financial aid purposes! However, if you had invested in a fixed annuity, do not worry because those monies are sheltered from the financial aid formulas. Now, your family (depending upon many other factors) can reasonably expect to receive some financial aid that you may not have received due to money that is open to discussion on your balance sheet!
Stephen J. Cagnassola
Wealth Protection Systems and upon distribution to the college-tax-free withdrawals!