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To make money work hardest, pay off car loan

Q. I have an auto loan at 8.8 percent interest and a balance of $4,766, which will be paid in full in October 1998. I have a checking account, which pays 0.75 percent interest, and a savings account, which pays 1.49 percent. Each of these accounts contains about $8,000, plus I have an annuity and several CDs.

Should I withdraw money from either of these accounts and pay off the auto loan balance? I would appreciate your expertise.

A. By all means, pay off your loan. The vast majority of car loans these days are simple interest loans, which means you can pay them off at any time without penalty by paying the principal and the accrued interest to date.

The overriding issue is what else you would be doing with the money. Repaying an 8.8 percent loan would make no sense if you would be so short of cash that you would turn around and run up credit card bills at 18 percent interest. Since you apparently are choosing between paying off the loan and keeping the money in the bank, the relevant questions to ask are:

+ Is the after-tax interest rate on the loan higher than the after-tax return you would be earning on the cash? Since consumer interest is not deductible but your bank account interest is taxable, leaving the money in the bank is costing you a lot.

+ What impact will repayment have on your emergency funds? You don't want to take your cash down to a level that you find uncomfortable. On the other hand, when you don't have to make a monthly car payment, you'll have extra income you can use to rebuild your savings. In addition, you need less emergency cash if you have the ability to borrow through an unused home equity credit line.

Whether or not you repay your loan, you should move most of your money out of these low-interest accounts. Keep $1,000 or less in a checking account and put the rest in a money-market mutual fund where you can earn a 4 percent to 5 percent return.

Q. One reader whose question was published in your column wrote that he had $700,000 in his individual retirement account. How is it possible to build up a $700,000 savings fund in an IRA when contributions are limited to just $2,000 a year?

A. When people retire or change jobs, they usually are eligible to roll over their retirement plan balances to an individual retirement account. In some instances, these balances are very large.

You can accumulate a significant sum by contributing $2,000 a year and investing it well, but you won't do it overnight. At a 10 percent annual return, it would take 38 years to get to $700,000.

Q. I have been thinking about signing up for the Florida Prepaid College Program for my children. Is this a good idea? When can you sign up?

A. The program is a good option for many families who consider it likely their children will attend a public or private college in state. If you buy the prepaid program and your children can qualify for one of the new Bright Futures scholarships, they will have a nice head start on paying college expenses.

One thing I like about the prepaid program is that it really reinforces the family expectation that children will go to college, which may motivate them to be better students in middle school and high school.

One drawback is that both the prepaid program and Bright Futures scholarships reduce eligibility for financial aid based on need.

The prepaid program is not a good idea for people who want their children to go to college out of state. It also is not the best alternative for young children whose parents are aggressive savers and investors. They probably can earn a better return on their own than the prepaid program offers.

The answer to your second question is that the prepaid program is now open for enrollment and will be through Jan. 9. Lump sum, monthly and five-year payment options are available. Prices start at $50 a month and vary with the age of the child and the program and payment option selected.

For information on the prepaid program, call (800) 522-4723 or visit the program's Internet site (http:wwww.fsba.state.fl.us/prepaid). Information about Bright Futures requirements is available at (888) 827-2004 or on the Internet (http://www.firn.edu/doe).

+ Helen Huntley writes about investing and markets for the Times. If you have a question about investments or personal finance, send it to On Money. We'll try to answer those we think are of greatest reader interest. All questions must be submitted in writing, but readers' names will not be published. Send questions to Helen Huntley, Times, P.O. Box 1121, St. Petersburg, FL 33731, or to huntleysptimes.com by electronic mail. +

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