Dr. Larry Hungerford, a former WSSU professor, is a partner at Bermuda Run’s Woodard & Company Asset Management Group, managing $460 million for clients.
The best gift you can give a young person is one that lasts and grows more valuable each year. Uncle Sam has provided three awesome tax shelters that you can fund for young members of your family.
By far the best known is the 529 college-savings plan that allows anyone to donate huge amounts ($300,000 plus in NC) that can be used tax-free for college or other post-high-school educational expenses including tuition, computers, books, room and board, etc.
Each state has a 529 plan that is open to any U.S. resident. Morningstar rates as the five best direct 529 plans the ones offered by Alaska, Maryland, Nevada, Ohio and Utah. However, NC’s plan, judged to be above average, is the one I use for my grandchildren. You can open an account for only $25 and have as little as $25 deducted monthly from your bank account. Check the details at CFNC.org or call 866-866-2352.
The flexibility built into 529 plans is stunning. Donors who control the accounts can change beneficiaries once a year. If your oldest child is academically gifted with a full-ride scholarship, you can switch his/her money to a younger sibling or even to yourself if you decide to go back to school. (There are no age limits.)
One reason that Morningstar doesn’t rate NC’s 529 plan higher is that it has only two all-stock investment options — the Vanguard Total U.S. Stock Market Fund and the Vanguard Total International Stock Market Fund. I recommend investing 75 percent in U.S. stocks and 25 percent in the international fund. If the money will be used before 2021, one of the stock and bond combination choices may be more appropriate.
Unlike the 529 plans that have no age or donor-income restrictions, the Coverdell Educational Savings Plan (ESA) is more limited but offers two terrific benefits:
• Besides paying for college expenses, ESA money can be withdrawn anytime tax free for any K-12 educational expense: private school tuition, SAT test prep courses, educational summer camps, etc.
• ESAs may be set up at discount brokers or at most mutual fund companies. At Scottrade you could buy stock in Disney (DIS) or Facebook (FB), or consider T. Rowe Price’s Large Cap Core Fund (PAULX) that can be bought for only $100 with no transaction fee. (Scottrade charges a $7 trading fee to purchase stocks.)
Only $2,000 in ESA money per year can be set aside per student and no additional contribution may be added once he/she reaches age 18. All ESA money must be used by age 30 to avoid taxes and a 10 percent penalty. The beneficiary could be changed to someone under 18.
High-income taxpayers are not allowed to donate to ESAs — over $220,000 for couples and $110,000 for individuals. However, they may gift money to other members of their family who then can open an ESA.
The last of my three best savings ideas for young people is the well-known Roth IRA. Unlike the two plans above, the beneficiary must have earned income which may be earned income from yard work, baby-sitting, or other work. (No W-2 form is required.)
Keep track of all the money paid for chores this year and any money earned from others to fund a 2016 Roth-IRA. The contributions can be used for any purpose tax-free; earnings (up to $10,000) may be used to buy a first-time home in 2021 or five years after a Roth is opened.
If he/she had earned income last year you can open a Roth for 2015 by April 18. Roth investment gains can also be used for college expenses without tax penalty but income taxes may be due.
Your gift may not be appreciated initially, but it certainly will be when educational expenses are due or a new home purchased. Feel free to call me at Woodard & Company at 336-998-7000 or e-mail larry@wcamg.com if you have questions or would like advice on investment options.