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Investments for grandchildren

Chris Farrell Jul 23, 2010

Question: I have some $ I would like to save for my grandchildren for college and would like to put it into a college fund for them but should they not go to college would they be able to use the money for something else. What fund would you suggest for this situation? Judi, Aragon, GA

Answer: If you want your grandchildren to have the freedom to use the money as they see fit when they’re older–and I think that’s wonderful–then I wouldn’t invest in a 529 college savings plan.

A 529 savings plan is terrific assuming they go to college. The earnings are free of taxes so long as they money goes toward qualified college educational expenses. But if they don’t go to college and the money isn’t used for that purpose the federal government sends a bill for ordinary income taxes owed plus plus a 10% penalty when the money is withdrawn.

A classic money gift without strings is savings bonds. I like the I-bond since it’s designed to be a hedge against inflation. But the Series EE is good, too. The money will grow tax-sheltered until they cash it in. Your grandchildren won’t make much interest on the investment, but there is no credit risk, either. The money will be there when they need it.

A riskier alternative is to purchase for each of them a broad-based low-fee equity index fund. Two well known examples are the S&P 500 equity index fund (it captures Big Business in America) and the Wilshire 5000 Total Market Index (it reflects the universe of publically traded U.S. stocks, big and small.) The money will have time to compound for your grandchildren during good and bad markets.

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