Saving for college? Put
all your tools to work.
(cont.)
Other popular investment vehicles for college funds include:
·
Coverdell Education Savings Accounts.
Up to $2,000 pretax can be invested annually in a so-called "education
IRA," which can be used to cover K-12 costs as well as college expenses.
Income from the accounts is tax-free when used to pay for allowed
expenses. There are limits on how much can be invested based on family
income, and funds must be spent before the student turns 30. It's worth
noting that setting up an education IRA does not affect a parent's
ability to invest $3,000 tax-deferred annually in his or her own
retirement account.
·
EE
U.S. Savings Bonds.
Interest earned from the bonds may be excluded from income if used to
pay qualified higher education expenses. The exclusion is phased out
beyond certain income levels, and the bond must be purchased after the
holder has turned 24. Newly issued Series I bonds will permit the same
exclusion.
·
Zero-coupon bonds.
Interest on these bonds is deferred until maturity, when it is paid in a
lump sum. It's important to understand, however, that you do have to pay
income tax on the interest as it accrues each year the bond is held. One
popular strategy, McNair says, is to "ladder" bonds so that they mature
successively, in every year of a child's college career.
·
UGMA/UTMA accounts.
Under the Uniform Gift to Minors Act, a
couple can make a joint tax-free
gift of $22,000 annually per child without affecting their lifetime
gifting exemption. The first $1,500 earned annually by such accounts is
given advantageous tax treatment. However, in what constitutes a huge
downside to such accounts, control of the money passes to the child when
he or she turns 18. (The age of transfer can be extended to 21 in some
states.) This means that funds earmarked for college can be spent on a
new convertible or any other transitory delight the child desires.
McNair says the "tax arbitrage benefits" of the accounts are minimal,
especially when weighed against the loss of parental control. Says Chan:
"Today, for most people, there are better choices." (The lifetime
gifting exemption, by the way, jumped to $1 million in 2002.)
·
Prepaid tuition plans.
Offered by individual states, prepaid plans are similar to but
potentially less risky than the 529 plans they helped inspire. They
allow parents to pay tomorrow’s tuition costs at today’s prices. Tuition
can be prepaid by the year or by the credit hour, depending on the
contract, and the “equity” one acquires won’t diminish, even if costs
increase tenfold by the time the child is ready to start college. Unlike
529 savings plans, prepaid plans aren't subject to the vagaries of the
stock market; so if you’re particularly risk-averse, this may be a way
to go. There are drawbacks, however: While funds from prepaid plans
often can be used in other states or applied to private school tuition,
some schools will not guarantee that increases in costs will be covered,
meaning you could come up short. Also, contributions to prepaid plans
reduce a student’s eligibility for financial aid on a dollar-for-dollar
basis, more than with a 529 plan. If a child decides not to attend
college, parents will be refunded their contributions -- in some states,
less any interest that may have accrued -- and they may be charged a
cancellation fee.
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