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Don't Make These 4 Money Mistakes

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You want to do right by your kids. But if you make the wrong moves with the money you've set aside to help them, much of your hard work could end up going to waste.

Keeping it together
Juggling the financial needs of your children with the rest of your family finances isn't easy, especially nowadays. But when it comes to saving for their children's college education, a lot of parents are making mistakes that are keeping their money from working as hard as it could for them. Let's take a look at some of those mistakes, along with the better way to handle the challenges that they raise.

Mistake No. 1: Giving up on 529 plans
529 plans should be the perfect solution for college savings. Working similar to retirement plans, 529s let you set aside chunks of money on a tax-deferred basis, letting income and capital gains accumulate within the account until you use them for college expenses. Use that money for college bills, and that income becomes tax-free, magnifying their value.

The problem, though, is that gains in 529s have been hard to come by lately. With most 529 plans having big allocations to stocks, tough markets over the past decade have severely limited the amount of growth most parents have seen in their plan accounts. High costs among some plans have made good performance even rarer.

As a result, parents are reducing their 529 contributions. According to the Financial Research Corporation, the average parent is setting aside barely $200 a month, down over 20% from a year ago. New account openings are down by more than half this year.

Although it takes some looking, there are some good 529 plans out there, with low costs and good investment options. And although the stock market hasn't been kind to savers lately, those with a long time horizon before their kids reach college have enough time to ride out these tough times and can expect better returns ahead.

Mistake No. 2: Using retirement funds to pay for college
Paying for college is a sacrifice many parents are willing to make. But you shouldn't sacrifice your own retirement for it.

Nevertheless, that's what many people are doing. A survey from Sallie Mae (NYSE: SLM  ) and Gallup showed that a quarter of parents expect to dip into their retirement accounts to pay for college.

That's a bad idea on a number of fronts. First, retirement assets ordinarily aren't included in financial aid considerations, but withdrawing from retirement accounts increases parents' income and reduces financial aid. Second, although there's no 10% early withdrawal penalty for IRA withdrawals used for higher education, you will still have to pay income tax if the money came from a traditional IRA.

But most importantly, every dollar you take out of your retirement accounts is a dollar that will never again be available for tax-deferred or tax-free growth. And given the woeful state of many families' retirement savings, you may well not be able to afford to take anything away from your retirement accounts.

Mistake No. 3: Investing too conservatively
Another Sallie Mae study shows that many college savers are looking for safe investments rather than ones that will grow. Although they come with FDIC insurance, these bank-offered products don't pay high enough interest right now to help people reach their goals.

For the financial institutions involved, college savings are a reasonable way to gain assets. Zions Bancorp (Nasdaq: ZION  ) , Fifth Third (Nasdaq: FITB  ) , and BB&T (NYSE: BBT  ) are among banks offering or planning to offer FDIC-insured products for 529 plans. Sallie Mae markets a high-yielding savings account both to college savers and the general public.

Conservative options are appropriate if your kids are close to college age. But if you still have a while to go, the question is whether earning just a few percent will give you the growth you need to afford to pay for college. Unless you can save huge amounts, the answer is likely to be no.

Mistake No. 4: Counting on loans
Despite their parents' best efforts, many students end up needing student loans. But counting on them can be a costly mistake.

A lot depends on what kind of loan you get. Government-sponsored loans often come with reasonable terms and rates. But private loans, which big banks like Wells Fargo (NYSE: WFC  ) , Citigroup (NYSE: C), and JPMorgan Chase (NYSE: JPM  ) offer, can come with much higher costs and interest, depending on your credit quality. Counting on private loans can add years to your child's debt obligations, making it that much harder to get a fresh start after graduation.

Make the right moves
If you're fortunate enough to be able to put money aside for a college education for your kids, don't waste the opportunity. By being smart with your investments, you'll get the maximum payoff for your efforts.

Stay tuned each Wednesday this month as Dan goes through the ins and outs of saving and paying for college.

True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community.

Fool contributor Dan Caplinger tries to learn from others' mistakes instead of his own. He doesn't own shares of the companies mentioned in this article. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policysold lemonade for its 529 plan when it was a kid.


Read/Post Comments (3) | Recommend This Article (16)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 13, 2010, at 9:16 PM, mathgeek2 wrote:

    Regarding "mistake number 1":

    This assumes that you do zero research before contributing to whatever fund you're buying. If nothing else, I'd recommend following established trends that haven't violated their long-term fundamentals. Think gold, silver, oil - most commodities in general.

    I don't do very much research on individual companies, but I dig into the market in which a company operates extensively before I invest in the company. That alone has gotten me 20% returns on many of my stocks - and I'm not selling yet.

    Following this methodology, investing in primary silver producers can be very promising. There aren't many pure silver miners, but those few are undervalued by 15 - 25%.

  • Report this Comment On October 14, 2010, at 2:20 AM, nivekluap wrote:

    First of all, nobody "deserves" to go to college. It has to be earned...just like a paycheck.

    The way I handled it went something like this. My children were told, by their freshman year in high school, if they wanted to go to college they would be in charge of filling out ALL the paperwork needed (FAFSA, applications for scholarships, and loans, etc.). Pocket change was all they were to expect from mom and dad. They were reminded of this occasionally.

    The youngest of my three kids is in his second year of college. It amazed me how all 3 took control of their future and are "making it happen".

    The youngest two have some loans and so do I, but it's on their shoulders to pay it back....until later, when they least expect it, I'll help them out.

    My point is this...save for your child's education,but don't tell them you are doing so. Make them work for it, and then pay up when they need it. Handouts aren't appreciated as much as rewards for hard work.

    KD

  • Report this Comment On October 14, 2010, at 11:58 AM, CPACAPitalist wrote:

    @nivekluap: I totally agree. My parents made sure to inform me that they would not be simply picking up the tab for my tuition, books, supplies, etc. I knew early on that the burden to acquire a college education was primarily on my shoulders. I took the initiative, worked full time and went to school in the evenings, or took classes online. Sure my parents helped me buy my books one semester here, or maybe filled my fridge with food a couple of times, but that was about it. The result is an education that I can trully appreciate since I sacrificed for it. And I did well in class and didn't waste time and money, because it was MY time and money. I plan on helping my kids with college, probably a little more than my parents because I will have the means to do so. Letting them know from day one that they can expect a free ride does them no good.

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Dan Caplinger
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Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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