Saving for College

By: Source: AARP.org Date Posted: 2006-04-17 13:35:22.717874-04:00

With college costs on the rise, more and more people are looking for ways to save for a college education. Today there are tax-advantaged options for saving for a child or grandchild's education. One of the most popular is the 529 college savings plan.

Overview of 529 College Savings Plans
529 plans are tax-advantaged ways that will help you save for college. There are two types: college savings plans that let you use the plan funds for expenses at any college, and prepaid tuition plans that let you lock-in future tuition at in-state public colleges at today's prices. Every state offers at least one of these plans. Contributions grow tax-deferred. Withdrawals are tax-free when used for qualified education expenses.

529 Plan Tips
Here are some issues to consider when choosing a college savings plan:

State Tax Advantages—You don't pay federal taxes when you withdraw money for education. In most states, withdrawals are state tax-free as well. In addition, several states provide state tax deductions or credits to in-state residents. So, if your state offers a good plan overall, it pays to consider the tax advantages.
Fees—All plans come with fees. Plans with high fees and commissions leave you with less money to save for college. Fees may include enrollment charges, plan maintenance fees, broker commissions, and fund management expenses. Look for plans with low fees so that you will have more money invested and working for you.
Investment Options—Compare the investment options and performance of different plans. College savings plans are typically invested in mutual funds. Mutual funds differ in terms of goals, risk and performance. Pick a plan that offers investments that match your needs.

Other Options
Other options for you to consider to save for college include Education IRAs and custodial accounts:

Coverdell Savings Account (Education IRA)
A Coverdell Savings Account is an education savings plan set up and managed by a parent, family member or guardian for the benefit of a child. Contributions to a Coverdell Savings Account are limited to $2,000 per year. Money deposited in the account can grow tax-deferred until distributed, and the child will not owe tax on withdrawals that are used for qualified primary, secondary and/or higher education expenses. The account is controlled by you for the benefit of the child. When the child reaches age 18 you may continue to manage the account or transfer account management to the child.
UGMA/UTMA Custodial Accounts
A Uniform Gift to Minors Act account (UGMA) or Uniform Transfers to Minors Act account (UTMA) are set up and managed by an adult for the benefit of a minor. Assets placed in a UGMA or UTMA are irrevocable and become the property of the child as soon as the gift is given. As the custodian of the child's account, you manage the assets until the child is old enough to assume control of the account. This is typically either 18 or 21 depending on the state where the account is held and the type of account. At that time, the child takes full control of the assets in that account and can use them for education or any other purpose. Keep in mind that because the funds belong to the child, they may limit the amount of financial aid that the child is eligible to receive. These accounts receive no special tax treatment. In addition, the child is not required to use the funds for education once he or she gains control of the assets.