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Time and Education
More on the Education IRA

by Ann Coleman (TMF [email protected])

Alexandria, VA (Jan. 13, 1999) -- As with almost anything else in investing, time is your most important ally. The Educational IRA is best suited for a long-term plan, and, despite its fairly puny annual contributions, it could make the difference between affording college or not.

There are other options and many other considerations when it comes to paying for college. So many in fact that the Fool has an entire series called Paying for College in our Fools and Their Money area. While you're there check out Investing for Your Kids for information on the tax ramifications of custodial accounts, IRAs (once they start working) and various other ways to build up cash for the little dears.

Yesterday we explored who qualified for these tax-free accounts and whether an Education IRA was even worth starting if your children were nearing college age. I think it is, but the effects will certainly not be as great as if you start early. Time --that's the secret. A good rate of return is helpful, too, of course, and that's where the Foolish Four can come in.

Speaking of the Foolish Four and "Time," today is a really good day to remind yourself that this is a long-term strategy. Our portfolio gave back half of its gains as the markets roiled and tumbled on news from Brazil. Such things happen.

The Education IRA was obviously not designed to let people accumulate enough tax-free cash to send their children to Harvard, but if you start early and achieve a high enough rate of return, it can probably finance two years at a community college and two more at the local State U.

If you have more ambitious plans, you will want other accounts as well, but the E-IRA is a great place to start. All you need is just $40 a month to maximize the allowed contribution. Let's see just how great it can be in time. In the very generalized example below I assumed starting the Educational IRA with $500 on the day a child is born and contributing an additional $500 on each birthday through age 18. The rate of return for the first year was assumed to be 5%. I used a rate of 18% after that, quite conservative for the Foolish Four, but who knows what the future holds?

Starting three years before you expect to need the money, $11,300 a year is transferred to a bank CD (still designated as an Education IRA, by the way, to keep its tax-free status). This removes the money from the ups and downs of the market and assures that it is available when needed. I am assuming that you can get 5% on a three-year bank certificate of deposit, so by the time you need the cash, (around the time the child turns 18 for the first batch, I'm figuring), it will have grown to over $13,000.00. If you are doing the community college thing, you could cut your first two withdrawals in half in order to leave more for State U.

Here's how it works, assuming that your return is exactly 18% a year -- which of course it won't be. However, if you average that rate through age 15 and get close to it from age 15 through 18, this will approximate how much cash the E-IRA will make available for college.

   Account Value on Birthday
Born     $500.00
 1       $525.00
 2     $1,209.50
 3     $2,017.21
 4     $2,970.31
 5     $4,094.96
 6     $5,422.06
 7     $6,988.03
 8     $8,835.87
 9   $11,016.33
10 $13,589.27
11   $16,625.34
12   $20,207.90
13   $24,435.32                Value
14   $29,423.67  Withdrawals   when needed
15   $24,009.94   $11,300.00   $13,081.16
16   $17,621.72   $11,300.00   $13,081.16
17   $10,083.64   $11,300.00   $13,081.16
18   $12,488.69   $12,488.69   $14,457.22

Note: Account totals in years 15 through 18 reflect an 18% increase over the previous year and the $11,300 withdrawal.

Inflation, the rising cost of higher education, and the college chosen will all influence just what percentage of your child's higher education expenses this will actually cover. But I can guarantee you that whatever that percentage is, you will be very happy to have it come matriculation day.

For those with Foolish offspring who are now in college or will be there shortly, check out FoolU.com for more on how to cope financially. Fool on and prosper!

Today's Stock Lists | 1998 Dow Returns

01/13/99 Close
Stock  Change   Last
--------------------
CAT  -2 11/16  48.06
JPM  -5  1/4   106.56
MMM  -2  1/2   75.25
IP   -1  7/8   44.63

                   Day   Month    Year   History
        FOOL-4   -4.31%   2.87%   2.87%   4.40%
        DJIA     -1.32%   1.83%   1.83%   1.43%
        S&P 500  -0.41%   0.42%   0.42%   1.81%
        NASDAQ   -0.17%   5.66%   5.66%   7.11%

    Rec'd   #  Security     In At       Now    Change

 12/24/98   24 Caterpillar   43.08     48.06    11.57%
 12/24/98   22 Int'l Paper   43.55     44.63     2.47%
 12/24/98   14 3M            73.57     75.25     2.28%
 12/24/98    9 JP Morgan    105.51    106.56     1.00%


    Rec'd   #  Security     In At     Value    Change

 12/24/98   24 Caterpillar 1034.00   1153.50   $119.50
 12/24/98   22 Int'l Paper  958.12    981.75    $23.63
 12/24/98   14 3M          1030.00   1053.50    $23.50
 12/24/98    9 JP Morgan    949.62    959.06     $9.44


                             Cash     $28.26
                            TOTAL   $4176.07

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