Kimberly Palmer

When Beth Moynihan, 28, and her husband, Sean, 29, found out they were expecting their first child in March, they quickly began wondering how, and if, they should start saving for future college costs. "Both of our parents were able to pay for our undergrad education, so we probably want to do a 529 plan," says Beth, adding that they also want to put money away for general expenses, such as future weddings and house downpayments.

Until recently, the couple, who lives outside of Baltimore, had saved for two purposes: retirement and a house downpayment. Beth, a nurse, and Sean, an engineer, put most of those savings into the stock market, where it's taken a beating. That leaves them wondering if they should put their child-related savings into safer spots, which might not pay much of a return. "I don't want to risk too much up and down," says Beth.

So what should new parents like Beth and Sean do with their savings? It turns out that there are some new strategies that work better than the traditional methods of saving.

The old methods include opening a Uniformed Gifts to Minors Act account, which automatically transfers into the child's name when he or she becomes an adult (18 or 21, depending on the state). The downside is that because the money automatically transfers, parents have no control over the funds after the child reaches that age, which means the child could spend it on anything. Similarly, buying a savings bond from the Treasury Department, which was once a favorite way of putting money aside for newborns, carries such a low interest rate today that there is little chance of keeping up with inflation, especially over the long-term. Certificates of deposit present the same problem.

Here are five new, smart ways to save instead:

529 college savings account

According to a recent survey by TD Ameritrade, 57 percent of adults have never heard of a 529 plan, even though financial advisors agree that it's the smartest way to save for college tuition. The accounts, which are sponsored by states, allow parents to invest after-tax money that then grows tax-free and remains tax-free if you use it to pay for tuition.

"Depending on the age [of your child], you will be more aggressive, and then become more conservative as your child gets older," says Jim Stoops, vice president and financial consultant at Charles Schwab. Many plan administrators offer funds that automatically make that shift for investors. Stoops adds that many employers let workers automatically funnel money from their paycheck into 529 accounts.

The accounts come with few limits on how much parents (or others) can contribute, regardless of income level. Parents have a lot of flexibility and can choose plans administered by any state, which means it pays to do some research comparing investment options and fees.

Some companies, including Upromise and Fidelity, also offer shopping rebates that go directly into 529 accounts. "I also think parents should encourage relatives to write checks toward a college savings plan instead of spending wildly on toys and video games for birthday and holiday gifts. UGift is a wonderful way to do this. It's a savings platform that's linked to 529 accounts administered by UPromise," says Stacey Bradford, author ofThe Wall Street Journal's Financial Guidebook for New Parents.

Prepaid tuition

Many states offer prepaid tuition plans, which let parents buy tuition at today's rates, essentially locking in a lower price, regardless of how much tuition rises. What many parents don't realize is that states let you use that pre-paid tuition at any school, including private colleges, anywhere in the country. That loophole makes prepaid tuition plans one of the smartest options available. "You can start buying tuition at today's rates, and the money is guaranteed by the states," says Stoops.

Brokerage accounts

Investing after-tax income into a brokerage account dedicated to your child provides maximum flexibility and the potential for high returns over the long term. Parents can set up an account directly linked to their paycheck, so money is transferred into the account each pay period, just like with their 401(k). "I always advocate automatic, biweekly contributions," says Stuart Rubinstein, managing director of client engagement for TD Ameritrade.

For a time span of ten years or longer, Ameriprise financial advisor Dawn Jurkovich says, "Put it in a moderate aggressive investment ... something with a higher dividend. Over a ten-year period, you can be more aggressive." The money can then be used for college tuition, living expenses, a wedding, or anything else.

A dedicated child's savings account

In today's market, savings accounts carry relatively low interest rates, but they come with other advantages, including the opportunity to teach children about money and savings as they get older. This savings account, in the child's name or the parent's name, can supplement the other, more aggressive investing strategies above. Some banks, including ING Direct, offer teaching materials along with kids' savings accounts, and waive fees for low balances as well as requirements for minimum account balances.

"Banks were charging exorbitant fees for parents to put $5 or $10 into a savings account so we created the kids' savings account," says Todd Sandler, head of product strategy for ING Direct. The website orangekids.com also helps children learn about money as they start to save and invest.

Your employer's college savings plan

Some companies offer direct deposit into a college savings account (such as a 529 plan), which makes it easier to automate savings. Joe Hurley, founder of SavingforCollege.com, says that while payroll deductions into 529 accounts is common, some companies avoid it because they don't want to be responsible for choosing which 529 plans they make available, especially if they have employees in more than one state. But it's worth asking your human resources department about it, and taking advantage of the deduction if it's available. Companies also sometimes offer small, private scholarships to employees' children, usually $1,000 or $2,000 to help defray some of the costs.

Beth and Sean Moynihan say they will probably start with the 529 plan and expand their savings from there. Meanwhile, they are trying to figure out how to find savings in their budget, even after their baby arrives. Says Beth: "We started talking about cutting back on vacations, traveling, and going out ... Then we can have more money for the baby's needs now."

 

Kimberly Palmer is the author of the new book Generation Earn: The Young Professional's Guide to Spending, Investing, and Giving Back .

Available at Amazon.com:

Lifecycle Investing: A New, Safe, and Audacious Way to Improve the Performance of Your Retirement Portfolio

Worry-Free Investing: A Safe Approach to Achieving Your Lifetime Financial Goals

Spend 'Til the End: The Revolutionary Guide to Raising Your Living Standard--Today and When You Retire

The Hard Times Guide to Retirement Security: Practical Strategies for Money, Work, and Living

Generation Earn: The Young Professional's Guide to Spending, Investing, and Giving Back

Happy at Work, Happy at Home: The Girl's Guide to Being a Working Mom

 

Personal Finance - 5 Smart Ways to Save Money for Your Children