Wednesday, January 4, 2006

What's the Best Way for Parents to Choose a College Savings Program?

We’re speaking with Nihara Choudhri, author of “Parent Savvy: Straight Answers to Your Family’s Financial, Legal, and Practical Questions.”

NOLO: Nihara, one of the difficult responsibilities of new parents is to choose a guardian for their child. The guardian is the person who will look after the child in the event that something happens to the parents. What factors should parents use when choosing a guardian?

NIHARA CHOUDHRI: It’s really a really tremendously personal decision to decide who you trust to take care of your child if you’re not around. There are lots of things you should think about, but one thing I would ask you to consider is, really, who loves your child and would have an interest in caring for your child and raising your child? Who does your child love, who does your child have a good relationship with, and would trust to be in his or her home? Who has the values that are closest to your own? You know, who has the same values on religion, and child rearing, and morality, and even things like economics, like how much money to give a child, and what type of lifestyle to raise a child. How many children are in this person’s family? If the person already has three or four children, that person might not be able to really accommodate and care for your child in addition to the children he or she already has. What kind of time does that person have available to care for your child? You know, if the person works eighty hours a week as a corporate lawyer, they might not have the time to really raise the child in the manner you would want your child to be raised.

NOLO: Once you’ve picked a guardian, how do you make that an official choice, so that a court will follow the parent’s instructions?

NIHARA CHOUDHRI: The most common way, and the safest way, is to prepare a will specifically naming a guardian for your child. Writing a will sounds expensive to parents who have to hire a lawyer to write a will… parents can hire a lawyer to write a will, and a lawyer will probably charge you maybe $500 to $1,000 to do a standard will, but you really don’t have to hire a lawyer if you have a simple estate and things aren’t too complicated. Nolo has some great products. If you like to use books, Nolo’s simple will book is a great book you can use; you just fill in the blank forms, and you’ll have your will ready in a couple hours. If you are a software person, Nolo’s Quicken Will-Maker Plus is a terrific tool; you can spend a few hours, and you’ll have a will that’s valid in the state that you live in, and you can buy both of these products for under $50, and get your will done in a weekend.

NOLO: Nihara, do you have to choose a family member as a guardian?

NIHARA CHOUDHRI: Absolutely not. You can choose anyone you want as your child’s guardian. You can choose a friend, you can choose a neighbor… but if you decide to choose someone who’s not a family member, I’ll give you two pieces of advice: first, think about talking to your family members in advance, and sort of let them know the decision you’ve made, and if you don’t have the courage to tell your mom or your sister in advance that you’ve chosen your best friend as the guardian, then, at the very least, write a letter to each of the important family members in your child’s life, and include it with your will -- something to reassure your family members, to explain your decision, to keep them from contesting your choice and going to court, and to encourage them to stay involved in your child’s life.

NOLO: One topic you devote some attention to in your book is health insurance. At what point does a new parent sign a baby up as part of the health insurance plan?

NIHARA CHOUDHRI: You have to sign your baby up for health insurance within thirty days of your baby’s birth. This is an incredibly, incredibly important rule. It may seem like an annoying administrative rule, but really, it’s a rule with important legal qualifications. If you don’t sign your baby up within thirty days, your baby could be subject to what’s called a “pre-existing condition exclusion” period. To make sure you don’t forget about it, what I would recommend you do is, before you go to the hospital - it may be in the last couple weeks before you do – call your health insurance administrator. Say, “I’m having a baby in the next couple weeks. What forms do I need to fill out, and how do I get my baby added to my health insurance plan?” That way, when your baby’s born, fill out the papers, and get the baby added to the health insurance plan right away. The same holds true for adopted children. You have thirty days from the time your child is adopted, or placed with you for adoption, to enroll your child in your health insurance plan if you want to avoid the very nasty effects of this pre-existing condition exclusion.

NOLO: You advise new parents to start thinking about college as early as possible. Why? Considering that it’s eighteen years away, can’t new parents have a few years without thinking about saving for college?

NIHARA CHOUDHRI: There are a few reasons for this. First, as most parents who are following the news know this already, but, college tuition costs are growing at a much higher rate than inflation. Last year, public universities increased their rates by about 7%, and inflation was just a little over 2%. So, if you just put your money under the mattress, your money’s not going to be working hard enough to keep up with the changes in college tuition prices. So, you need to come up with some kind of plan to beat inflation. The other reason I say start saving early is to take advantage of the long-time horizon. If you take just a little bit of money a month, and invest it over a really long period of time, the power of compound earnings will make that money grow… a small amount of money can grow into a huge amount of money over time. For example, let’s say you set aside $50 a month. $50 a month is, you know, I like to think of it as maybe a couple of Chinese take-out dinners, or a couple of movie tickets and some popcorn, and there you’ve got your $50. Invest that over the course of eighteen years, every month you sock in $50 a month, you’ll have $20,000 by the end of eighteen years, which is a huge chunk of change. The last reason parents should begin saving for college early is because you don’t want to have to worry about the ups and down of the market. I mean, in any given couple of years, the market could go up, or it could tank, and you don’t want to be terrified thinking, “Oh my God, my child is going to college in five years, and the market has tanked,” because over time, the market tends to go up. So, if you take a long-time horizon, you don’t have to worry about the ups and downs.

NOLO: Let’s say that a new parent has the ability to put money away for the child’s education. What do you recommend?

NIHARA CHOUDHRI: There are lots and lots of plans out there; there are all kinds of plans. My two favorite plans are the 529 College Savings Plan, and the Coverdell Education Savings Account. Both plans work similarly from a tax perspective. You throw post-tax dollars in there, so it’s not, again, not like a 401K, not pre-tax dollars, it’s post-tax dollars. You put it into these plans, and any income or any earnings on the money you invest is tax-free, which means you will not pay capital gains taxes on any of the earnings on the money, provided you use it for a child’s higher education expenses. You can use the money in these plans to pay for tuition, room and board, books, fees… so, they’re really great plans. The difference between a Coverdell ESA and a 529 College Savings Plan is that a Coverdell ESA is even more flexible, and you can use the money to pay for private school tuition for elementary and secondary school, you can use it to pay for academic tutoring, for internet access… it’s much more flexible. So, those are the differences.

NOLO: How much money can you invest in a Coverdell ESA?

NIHARA CHOUDHRI: A Coverdell Education Savings Account, because the plan is so flexible, is actually pretty restricted in terms of how much you can invest. You can only invest $2,000 per year per child, and the plan is subject to income limits. So, if you make more than a certain amount of money, you do not qualify for the Coverdell ESA.

NOLO: How much can a parent invest in a 529 account?

NIHARA CHOUDHRI: In a 529 Savings plan, there are no income limits, so it doesn’t matter how much you earn; you could make $2,000,000 a year, and you’re still eligible for a 529 Savings Plan, and a 529 Savings Plan has really high investment limits, so, it’s something like, you know, most plans let you invest a couple hundred thousand dollars or more, so there’s plenty of room to maneuver with a 529 Savings Plan.

NOLO: How do you go about choosing the right 529 Plan?

NIHARA CHOUDHRI: There are lots of different 529 Savings Plans; each state has its own 529 College Savings Plan. Some states actually offer tax deductions for investing in the state’s College Savings Plan. So, for example, in New York, if you invest in the New York 529 College Savings Plan, you get an immediate in-state tax deduction for the money you invest. So, if you’re a New York resident, it’s kind of a no-brainer to invest in the New York plan. But many other states don’t have the tax breaks, so you might want to shop around. Even if you live in California, you might not want to go with the California 529 plan. You know, look around, take a look at the other states’ plans, and make a choice based on the manager of the fund. It’s sort of like choosing a mutual fund; you know, make a choice based on the history, the performance of the fund, the management fees… and a great website to begin researching different 529 Savings Plans is

QUESTON: Considering that people have been having babies for thousands of years without your help, why do you think parents would need your book?

NIHARA CHOUDHRI: I’ll tell you why; I’m a lawyer, and I’m a mom, and I thought because I was a lawyer that I knew enough about the basics of the legal and financial side of raising a child, that I thought, “Oh, I’m covered.” But, when I got asked to write this book, I started doing all kinds of research in writing every chapter, and, I kid you not, I changed something in my life every month when I wrote a chapter of this book, and I’ll give you a couple of examples. When I wrote the college savings plan chapter, I did all kinds of research; I had to learn about everything from 529 Savings Plans to savings bonds, and that’s when I realized, “Okay, we have to start saving for college now,” and in our family, the 529 Savings Plan in New York state made the most sense. We threw some money in there, and we saved several hundred dollars in New York state taxes; we got a refund for money that we would have saved in some way anyway, but we got a refund, and I wouldn’t have done this this quickly had it not been for the research I did writing this book. Another example is, I had to do a whole chapter on tax breaks for new parents, and one of the things I researched was the dependent care account, and that dependent care account lets you use pre-tax dollars to pay for child care expenses, and what I learned is that I can use that account to pay for preschool. So, this year, I’m paying for preschool using pre-tax dollars, and thanks to all the taxes we pay in New York, it’s more or less cutting my preschool bill in half, and it’s huge savings. So, I personally have learned so much from writing Parent Savvy; it’s helped me to be a parent to my son, and I hope it will help you be a better parent to your child.

NOLO: Nihara, thanks so much for talking with us today.

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