Teaching kids about money

maple2 · March 2015

vlagrl29 said:

maple2 said:

vlagrl29 said:

jtmh2012 said:

MissChanandlerBong said:

I love all these replies - thanks everyone!

One question - would you suggest having a regular savings account for your kid(s), an education account (ESA/529), or both? We have put all of the girls' money into a 529 so far but I'm wondering whether we should have regular savings accounts too.

We opened a savings account for our little one as soon as we had a SSN. Our a credit union regularly runs 3%,4%,5% 1-yr CD specials. However, it is 1 per member. So now we get one in each of our three names.

We're debating the 529. While we intend to raise him with the idea of going to college, I look at my brother who never went.
This is us. We won't ever do a 529 because who knows if she will go or not (preferable we hope so). MIL has a CD set up at their bank and we have a savings account for her at ourbank. Eventually we will move it into a money market account.
Everyone has to weigh the pros and cons of 529s for themselves, but it worth remembering that the penalty for not using the 529 for education is being taxed on all the interest you earned during that period plus a 10% penalty on the interest. You don't lose any of your principle (at least to taxes or penalties). Depending on interest rates, market performance and the amount you invest, you may come out with about the same amount of money after paying taxes and penalties on a 529 as if you had just kept the money in a savings account the whole time.

I just did a quick check of this recently for my own research. I assumed a steady 7% rate of return for money invested in the market, a constant 1% interest rate on savings, and an income tax rate of 25%. I only calculated the interest growth once per year rather than compounding it within years because I was just trying to get a sense of how things might work rather than be super accurate. I also assumed a single investment when the child was around 3. If you invested $1000 in a 529 for 15 years then paid the 10% penalty and 25% taxes on the interest, you would end up with $2,026.05. If you had just put that $1000 in a savings account you would have $1,149.47. If you did use the 529 for school, you would have $2,578.53.

If you started with $10,000, you would end up with $20,260.47 going the 529 route and $11,494.74 with savings. If you used it for school, though, you would have $25,785.34. A lot of things about my scenario are unrealistic, but it helped me get over some anxiety about investing in a 529 then not needing it all for school for the kids. In then end, we may not be that much worse off than if we took a very conservative investment approach with that money. If they do in fact use it to go to school we will be much better off. Yes, it would suck to lose almost >$5,000 to penalties and taxes, but we would still come out ahead of a savings account.

It still may not make sense to use a 529 if you are sure your child won't attend college (or higher education of any sort), are worried about losing principle due to market performance, or for any number of other reasons, but it's worth thinking about some actual numbers. Taxes and penalties sound a bit scary in the abstract, but they may not be so bad in reality. At least compared to alternatives. Again, my numbers are not super realistic or accurate, so you would want to run scenarios with numbers that feel comfortable to you.
I get what you are saying, but I would rather not get taxed and then it be as income and probably get us into the next tax bracket. With a money market we can still invest it and get better gains than a normal savings.

You should definitely do whatever feels most comfortable for you. Based on my (admittedly not super accurate) scenario, I would need to earn >5% interest to do better than the 529 even with penalties and taxes. And, I just realized that doesn't even take into account the taxes I'd have to pay on that interest.

In terms of taxes, even if you were pushed into a higher tax bracket, it would only be on the amount you took out of the 529 that was over the threshold for your current tax bracket. Your regular income wouldn't be affected at all. I also suspect that you could withdraw the money from the 529 over time rather than all at once to try keep all it from being taxed at a higher rate. I don't know that for sure, though.

Again, I'm not trying to suggest that a 529 is right for everyone, just that it's worth thinking about the trade-offs using actual numbers.