Finances for your future

WHERE TO START

Consider a family of three: mom, dad and baby.

The new parents want to start putting money away for college but are not sure about the best way to do that. Should they buy savings bonds? Set up a savings or other type of account?

Many people have fond memories of receiving savings bonds from relatives. However, financial experts say savings bonds don’t earn enough interest to be a wise investment.

For instance, as of Nov. 1, the earnings rate for Series I Savings Bonds°was 1.38 percent and included a fixed rate of .20 percent, according to the United States Treasury.

Financial experts say savings bonds often don’t outpace inflation and recommend cashing them out and putting the money into something that will yield a higher growth.

Most experts agree that the best route is a 529 college savings plan.

In South Carolina, the Future Scholar is a qualified 529 college savings plan that helps parents or guardians save for a child’s college education.

There are many advantages to a 529. It’s tax-free growth of college savings; the account owner has full control; there is a low impact on college financial aid; there are high contribution limits; and no age or income limits.

“Future Scholar is a smarter choice than many other college savings vehicles,” according to the state of South Carolina.

“Your child can use the money you save through Future Scholar to pay qualified education costs at any eligible educational institution in the United States, as well as some international schools,” the state says. “This includes two- and four-year public and private colleges, graduate and professional programs and certain vocationaltechnical schools.”

Those parents who file a South Carolina tax return, either as a resident or nonresident, may also be eligible for additional tax advantages. The money they put into a Future Scholar account may be tax-deductible up to the maximum account balance limit of $370,000 per beneficiary or any lower limit under applicable law.

Additionally, some college savings vehicles transfer account assets to the child as early as age 18, but not so with Future Scholar. The parents control when distributions are made and what the funds will be used for. Also, if the child receives a scholarship or decides not to attend college, the Future Scholar money can be transferred to a new beneficiary, as long as he or she is a qualified relative of the original beneficiary.

A 529 is also a great option when relatives or friends ask what to get the child for a birthday or holiday. Parents can encourage them to contribute to the 529.

TIME MARCHES ON

As the child grows, parents can start saving for their — and their own - future in a variety of ways.

First, it’s a good idea to have an estate plan in place, which includes a will and a living will. A will spells out where a person wants their money to go when they die and a living will spells out what the person wants in the event of a life-prolonging medical treatment.

One myth is that trust funds are only for wealthy people. Trust funds are simply a way for a person to reduce estate and gift taxes and see that their assets are distributed without the delay and cost of probate court.

While parents are making plans for the future, they should also begin teaching their child about financial responsibility.

There are a variety of ways to do this (and have fun too!).

Playing the stock market is a good place to start. One expert recommends buying stock in Disney and then framing the stock certificate on the wall. As the child gets older, that stock can help the parent teach the child how the market works.

Another choice is a traditional savings account for the child.

Parents can start by contributing to the account and as children get older, they can do their own banking. Parents can also set up their own version of°a 401(k) and match funds that the child has earned through babysitting or other jobs.

Some banks and credit unions offer special savings account to teach young children about saving. Many also offer prizes and other incentives to young savers. Additionally, several banks in South Carolina offer significantly higher rates on children’s savings accounts.

And when the holidays or birthdays roll around, parents again should encourage family and friends to contribute to the child’s savings account.

RETIREMENT PLANNING

As parents plan for their children’s future, they should also be focusing on planning for their own retirement.

“A secure, comfortable retirement is every worker’s dream, and now because we’re living longer, healthier lives, we can expect to spend more time in retirement than our parents and grandparents did,” according to the Social Security Administration.

The SSA provides detailed information about Social Security retirement benefits under current law. Its website, www.ssa.gov/retire2, offers a calculator to estimate retirement benefits.

According to the SSA, the average monthly Social Security benefit for a retired worker was about $1,230 at the beginning of 2012. This amount changes monthly based upon the total amount of all benefits paid and the total number of people receiving benefits But it’s pretty clear that anyone would have a difficult time living on a little over $1,200 a month. Other options include 401(k) plans, IRAs and Roth IRAs.

Contributions to a 401(k) can cut a tax bill by reducing taxable income. For instance, if you earn $65,000 a year and contribute $8,000 to your 401(k), you’ll pay income taxes on only $57,000, according to the AARP.

The advantages, the AARP says, are that many employers match contributions; taxes are only paid on withdrawals; and when a person leaves a job they can transfer the money into a tax-free traditional IRA.

The disadvantages are that withdrawals are subject to ordinary income taxes, plus a 10 percent early withdrawal penalty depending on age.

The next option is an IRA.

According to the AARP, a person must have earned income to contribute to a traditional IRA or to a Roth IRA.

The advantages of a traditional tax-deductible IRAs are that contributions reduce taxable income. Additionally, “your investment choices are almost unlimited. You can put virtually any bank, brokerage, mutual fund or insurance product into an IRA,” the AARP says.

With traditional nondeductible IRAs, earnings are untaxed until they’re withdrawn.

“A nondeductible IRA makes sense only if you’re ineligible for a traditional deductible IRA and your earnings disqualify you for a Roth IRA,” the AARP states.

A Roth IRA is another option.

The advantages are that earnings grow untaxed, contributions can be made at any time without incurring a penalty; and all Roth IRA withdrawals are tax-free if the person is age 59 ½ and has owned the account for at least five years.

Additionally, withdrawals don’t count as income in the formula that determines whether Social Security benefits are taxable. The disadvantage is that contributions won’t reduce a current tax bill. There are also strict eligibility requirements.

But, “even a modest Roth IRA can enhance retirement security,” the AARP says. “Remember, distributions from a 401(k) and traditional IRAs are taxable. If you’re in a 28 percent bracket, you’ll get 72 cents to spend on living expenses for every dollar you withdraw. Taking those big distributions in a falling market can leave your nest egg too depleted to recover fully.”

The thing to remember, experts say, is that investing is a long-haul process and is often best left to the experts.

How do you choose an expert? Look for a financial adviser who is a certifie financial planner. They’re licensed and regulated, plus take mandatory classes on financial planning.

Finally, it’s important to know that it’s never too late to plan for you and your child’s future.

TAXES ON MONEY GIFTS

Monetary gifts are common between family members and friends, but the Internal Revenue Service (IRS) imposes a gift tax on large monetary gifts. Small monetary gifts such as a $50 gift from a grandparent to a grandchild for Christmas will not incur the gift tax, but larger gifts that exceed $13,000 may incur tax. If you are giving or receiving a large sum of money it is important to understand the implications of the gift tax. According to the IRS, monetary gifts that exceed an exclusion of $13,000 may be subject to the gift tax. If a gift you receive is less than this amount, it will not be subject to the gift tax. Other gifts that are usually excluded from the gift tax are payments made toward someone else’s health care bills or education, gifts given to a spouse, and gifts given to political organizations. The exclusion limit is $13,000 per person, meaning married couples giving gifts can give a total of $26,000 before the gift would incur the gift tax.

Payment of the gift tax is typically the responsibly of the person giving the gift, not the person receiving the gift. In other words, someone who gives you $50,000 will not cause you to incur the gift tax, rather the giver must report the gift on his tax return. The gift tax return is due on April 15 following the year in which the gift is made. Failure to report gift taxes could potentially lead to fees or other penalties.

The gift tax applies to monetary gifts given on an annual basis. This means that if you gave two gifts to the same person within the same year, you would incur the gift tax if the sum of the gifts exceeded $13,000. On the other hand, if you gave someone $13,000 one time every year for the next 10 years, none of the gifts would incur gift tax. Gifting in this fashion can potentially allow someone to pass on money to family members or friends over time without incurring the estate tax on those funds when they die.

The gift tax applies to gifts made to each single recipient, but there is no limit on how many recipients one can give to. In other words, a rich person with a large family could give $13,000 to each of his 50 grandchildren each year without incurring gift tax. There is also no limit on how many gifts a single person can receive from different donors. Ten different family members could give you $13,000 without incurring gift tax.