Ask SmartMoney: College Savings, SUVs, Stock Buybacks

QUESTION: My son and his wife just had their first child. I want to assist with future college bills. Should I save money for her in an IRA or use a 529 prepaid tuition plan?
— Larry Choate, Vancouver, Wash.

ANSWER: We don't normally admit this, but saving money for college costs in an IRA — particularly a Roth IRA — isn't a bad idea. Contributions to a Roth (up to $6,000 a year if you're 50 or older) can be withdrawn at any time for any reason, and earnings can be withdrawn completely tax-free once you're over age 59 1/2 and the account has been open for five years. So should your granddaughter decide to (heaven forbid) skip college and join a rock band, you can use that money without penalty however you see fit. We don't usually recommend this strategy because most folks — particularly, young parents — need to focus on saving primarily for retirement. And while you can borrow to pay for tuition, you can't borrow to pay for retirement.

There are two types of 529 plans; the prepaid tuition version is the more conservative. Here, you buy chunks of future tuition at today's prices for in-state public universities; the account grows tax-free. A 529 savings plan works more like an IRA; you pick a state-sponsored plan largely according to its underlying investments and fees. In either case, you can withdraw funds for use at almost any educational institution, no matter where it is. Some states even offer tax breaks. But should your granddaughter opt not to attend college, you'll have to roll the account over to another family member or you'll owe income tax plus a 10 percent penalty on earnings withdrawals. Visit www.smartmoney.com/college for more advice on the best ways to save.

QUESTION: I'm a shareholder of a company that announced a stock buyback. What are the consequences of this?
— Geoffrey Briggs, Delray Beach, Fla.

ANSWER: A stock buyback (also known as a share repurchase program) is when a firm buys its own shares at the current market price, thereby reducing the number of shares available for trading. It's a way to reward existing shareholders, since fewer outstanding shares means each shareholder owns more of the company. (It also makes many key metrics, such as earnings per share, more robust.) While hardly new, this tactic has become increasingly popular, with the biggest firms buying back more than$1 trillion of their stock in the past two years, according to Standard & Poor's.

Buyback announcements sometimes — but not always — signal that management thinks shares are undervalued. Repurchased shares can also be used to satisfy exercised employee stock options and can be handy for mergers and acquisitions, says Howard Silverblatt, Standard & Poor's senior index analyst. Exxon Mobil, AT&T and Hewlett-Packard had the biggest buybacks during the first quarter of 2008. On the downside, some companies use a buyback plan to buy a little goodwill among investors, even if there are better uses for the firm's cash. You won't usually see a dramatic impact on the stock when a company announces a buyback plan — the terms of a buyback aren't set in stone, they're simply a directive by the board of directors to allow management to buy shares, if they choose, within a certain time or price range.

QUESTION: Is it a smart step to trade in my five-year-old Lexus SUV (all paid) for a Toyota Prius?
— Olga Vetokho, Buffalo Grove, Ill.

ANSWER: Not if your only motivation is to reduce the number of swear words you mutter with each fill-up. Once you factor in depreciation, what you'll fetch trading in a five-year-old gas guzzler isn't going to pay for a new Prius. You'll likely have a $10,000 price differential, which several years of cheaper fill-ups alone won't cover. "You're probably better off looking for other ways to save, like carpooling, public transportation and telecommuting," says Philip Reed, senior consumer-advice editor for Edmunds.com, which has a calculator to help with these types of decisions.