Investing For Dummies. Eric Tyson

is taxed at your child’s rate, which is presumably a lower tax rate than yours.

      Education Savings Accounts

Be careful about funding an Education Savings Account (ESA). In theory, an ESA sounds like a great place to park some college savings. Subject to income limitations, you can make non-deductible contributions of up to $2,000 per child per year, and investment earnings and account withdrawals are free of tax as long as you use the funds to pay for elementary and secondary school or college costs. However, funding an ESA can undermine your child’s ability to qualify for financial aid. It’s best to keep the parents as the owners of such an account for financial aid purposes, but be forewarned that some schools may treat money in an ESA as a student’s asset. These accounts are considered the student’s asset if the student is listed as the account owner and is an independent student.

      One final detail about ESAs. Most investment companies have done away with these accounts since 529 plan account holders (discussed next) may now use withdrawals to pay for K–12 educational expenses. Thus, there are no longer notable differences between the two types of accounts, and the 529 plan allows for saving and investing far greater balances than the ESA.

      Section 529 plans

      Also known as qualified state tuition plans, Section 529 plans offer a tax-advantaged way to save and invest more than $100,000 per child toward college costs (some states allow upward of $300,000 per student). After you contribute to one of these state-based accounts, the invested funds grow without taxation. Withdrawals are also tax-free so long as the funds are used to pay for qualifying higher educational costs (which include college, graduate school, and certain additional expenses of special-needs students) and for up to $10,000 per year for K-12 educational expenses. The schools need not be in the same state as the state administering the Section 529 plan.

      

As I discuss in the preceding section dealing with Education Savings Accounts, Section 529 plan balances can harm your child’s financial aid chances. Thus, such accounts make the most sense for affluent families who are sure that they won’t qualify for any type of financial aid. If you do opt for a section 529 plan and intend to apply for financial aid, you should be the owner of the accounts (not your child) to maximize qualifying for financial aid.

      Allocating college investments

      If you keep up to 80 percent of your investment money in stocks (diversified worldwide) with the remainder in bonds when your child is young, you can maximize the money’s growth potential without taking extraordinary risk. As your child makes his way through the later years of elementary school, you need to begin to make the mix more conservative — scale back the stock percentage to 50 or 60 percent. Finally, in the years just before your child enters college, whittle the stock portion down to no more than 20 percent or so.

Diversified funds (which invest in stocks in the United States and internationally) and bonds are ideal vehicles to use when you invest for college. Be sure to choose funds that fit your tax situation if you invest your funds in non-retirement accounts. See Chapter 8 for more information.

PAYING FOR COLLEGE

      If you keep stashing away money in retirement accounts, it’s reasonable for you to wonder how you’ll actually pay for education expenses when the momentous occasion arises. Even if you have some liquid assets that can be directed to your child’s college bill, you will, in all likelihood, need to borrow some money. Only the affluent can truly afford to pay for college with cash.

      One good source of money is your home’s equity. You can borrow against your home at a relatively low interest rate, and the interest is generally tax-deductible. Some company retirement plans — 401(k)s, for example — allow borrowing as well.

      A plethora of financial aid programs allow you to borrow at reasonable interest rates. The Unsubsidized Stafford Loans and Parent Loans for Undergraduate Students (PLUS), for example, are available, even when your family isn’t deemed financially needy. In addition to loans, a number of grant programs are available through schools and the government as well as through independent sources.

      Complete the Free Application for Federal Student Aid (FAFSA) to apply for the federal government programs. Grants available through state government programs may require a separate application. Specific colleges and other private organizations, including employers, banks, credit unions, and community groups, also offer grants and scholarships.

      Many scholarships and grants don’t require any work on your part — simply apply for such financial aid through your college. However, you may need to seek out other programs as well. Check directories and databases at your local library, your kid’s school counseling department, and college financial aid offices. Also, try local organizations, churches, employers, and so on, because you have a better chance of getting scholarship money through these avenues than through countrywide scholarship and grant databases.

      Your child can also work and save money for school during high school and college. In fact, if your child qualifies for financial aid, she’s generally expected to contribute a certain amount to education costs from employment (both during the school year and summer breaks) and from savings. Besides giving your gangly teen a stake in her own future, this training encourages sound personal financial management down the road. For more advice and specific strategies regarding affording and paying for higher education, please see my book Paying For College For Dummies (Wiley).

Protecting Your Assets

      You may be at risk of making a catastrophic investing mistake: not protecting your assets properly due to a lack of various insurance coverages. Manny, a successful entrepreneur, made this exact error. Starting from scratch, he built up a successful million-dollar business. He invested a lot of his own money and sweat into building the business over 15 years.

      One day, catastrophe struck: An explosion ripped through his building, and the ensuing fire destroyed virtually all the firm’s equipment and inventory, none of which was insured. The explosion also seriously injured several workers, including Manny, who didn’t carry disability insurance. Ultimately, Manny had to file for bankruptcy.

      

Decisions regarding what amount of insurance you need to carry are, to some extent, a matter of your desire and ability to accept financial risk. But some risks aren’t worth taking. Don’t overestimate your ability to predict what accidents and other bad luck may befall you.

      Here’s what you need in order to protect yourself and your assets:

       Major medical health insurance: I’m not talking about one of those policies that pays $100 a day if you need to go into the hospital, or cancer insurance, or that $5,000 medical expense rider on your auto insurance policy. I know it’s unpleasant to consider, but you need a policy that pays for all types of major illnesses and major medical expenditures. The health insurance arena went through major changes due to the Affordable Care Act (Obamacare). See Chapter 14 for information on health insurance for small-business owners. Consider taking a health plan with a high deductible, which can minimize your premiums. Also, consider channeling extra money into a Health Savings Account (HSA), which provides tremendous tax breaks. As with a retirement account, contributions provide an upfront tax break, and money can grow over the years in an HSA without taxation. You can also tap HSA funds without penalty or taxation for a wide range of current health expenses.

       Adequate liability insurance