It is Time to Start Preparing for Back to School!
As we prepare for the start of a new school year, it is the perfect time to review and reassess your financial strategies in supporting your child’s educational future. We want to ensure that you have the necessary tools in place to put both yourself and your family in the best position to succeed. This month, we will focus on three key aspects of educational funding: education accounts, compounding interest, and risk tolerance.
A few months ago, we spoke about 529 plans. As a quick recap, 529 plans are a great tool to fund education goals. Contributions grow tax-free and are tax-exempt when withdrawn, as long as they are used for qualified educational expenses. Another popular account is the Coverdell Education Savings Account (ESA). This type of account also covers a wide variety of educational expenses, while growing tax-free as well. For a bit more flexibility, many people turn to Uniform Transfers to Minors Act (UTMA) and Uniform Gift to Minors Act (UGMA). These types of accounts can be used for other expenses besides educational ones. The downside is, there are no tax-exempt withdrawals, rather they typically will be taxed at the child’s tax rate.
The earlier you start saving for college, the better the likely end result. One of the major reasons behind this effect is something called “compound interest.” Compound interest is the process where your earnings grow as well as the principal of your initial investment. A longer period of time for your money to grow, leads to a greater compounding effect. As an example, $10,000, growing at 5% per year for five years, will reach a value of $12,763. The same investment held for twenty years projects to a level of $26,533. As you can see, it takes time to see the real effects of compounding interest, but the earnings difference in the end can be substantial.
Risk tolerance is something that is unique for each person’s situation and willingness to invest their money. Typically, a more aggressive investor prefers to have a longer time period. Although there is potential for higher returns, there is also the possibility of losing money. The additional years historically allow the investor time to recover from any extreme market fluctuations. Conversely, as the time to pay for educational expenses approaches, typically investment strategies become more conservative to protect those assets even at the cost of lower growth.
It is never too late, and certainly never too early, to begin thinking about your plan for funding future educational expenses. Starting early, creating a plan and sticking to it leads to a strong financial foundation even if early contributions are small. If you have any questions or if you would like to learn more, please contact me, and we can discuss in more details the what the best course of action is for you!
Osaic FA and its representatives do not provide legal or tax advice. You may want to consult a legal or tax advisor regarding any legal or tax information as it relates to your personal circumstances.
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