Saving for Your Child's Education

All parents want their children to achieve their fullest potential – and most agree that education is the key. Not only is education considered the path to economic independence and even wealth, but many also believe that a good education makes a good person.

An education, of course, comes with a price – and a hefty one at that. From preschool through graduate school, education bills will be among your heaviest financial burdens as a parent. Fortunately, there are a number of strategies that you can use to maximize the savings you sock away for your child's education. Here is a brief overview of your best savings options.

Coverdell Education Savings Accounts
By far the most flexible education savings plan, a Coverdell education savings account (Coverdell ESA) provides tax-free treatment for your investment earnings. Although this type of account caps the amount you can save ($2,000 per year), you can use the money for a broad array of educational expenses – such as private school tuition, academic tutoring, and a computer for high school – in addition to college and graduate school tuition.

529 College Savings Plans
These plans allow you to save as much as a quarter of a million dollars for your child's higher education expenses every year – and you won't owe any capital gains taxes on the appreciation. The major drawback to this type of plan is that it covers only college and graduate school expenses – so private high school, for example, doesn't count.

529 Prepaid College Tuition Plans
As the name suggests, these plans allow you to pay for tomorrow's college tuition expenses at today's prices. Although they can be quite a bargain, the plans limit your child's college choice to the schools participating in the program. And there's no guarantee the plans will be around forever – as of this writing, one prepaid tuition plan has shut down completely and several others are no longer accepting new enrollments.

Education Savings Bonds
If you're more concerned about losing your money in an economic downturn than interested in profiting from a bull market, U.S. savings bonds offer a guaranteed (but small) return on your original investment. You will not owe any taxes on the interest you accrue on a Series EE or Series I savings bond, provided you use the money to pay for your child's college or graduate school bills.

Custodial Accounts
Although these accounts are not specifically for education savings, they allow you to give money directly to your child without the expense and administrative hassle of setting up a conventional trust. You don't have to spend the money in your child's custodial account on your child's educational expenses, but can instead spend the money for your child as you see fit. Although there is no tax exemption for custodial accounts, the earnings in the account get taxed at your child's lower rate rather than your tax rate.

Roth IRAs
Although a Roth IRA is technically a retirement plan, a nifty exception allows you to withdraw money from your Roth IRA – without paying a penalty – to cover your child's higher education expenses. The Roth IRA is an excellent choice for slightly older parents, because you won't owe any taxes on the earnings if you withdraw money from the account after you reach age 59. (Before age 59, you'll owe taxes on the earnings, but not on your original contribution, if you take money out to pay for higher education.)

Source

Nolo Legal Press ©2010

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