Where to Stash Cash For College

How old are your kids? How much have you saved for their education? If your answer is “not enough,” you are not alone. Most people don’t really start to save for college until their kids are teenagers, and a third of parents who intend to send their kids to college have saved less than $5,000. But you aren’t alone: Uncle Sam can help. Today’s tax laws give you some unique new tools to boost college savings. Here are a few:

An IRA for Your Child
If your child has earnings , she can contribute to an IRA in her own name. When she draws out the money to pay for college, she’ll pay tax at her income tax rate, but penalties will be waived because the money is used for college. If she puts the money into a Roth IRA, she won’t get a tax deduction when the contribution is made, but the money will grow tax-free, and she can pull out all her contributions (but not the earnings) tax- and penalty-free to pay for college.

An IRA for You
You can contribute to a Roth IRA in your own name if your income is $95,000 or less ($150,000 on a joint return.) You can take out the contributions tax- and penalty-free to pay for your child’s college costs, and the earnings will continue to grow in the account, to help pay for your own retirement.

An Education Savings Account
These accounts, also known as Coverdell ESAs, let you sock away $2,000 a year for any child under age 18, if you don’t exceed the income limitations. Withdrawals are tax free if used for education expenses for elementary and secondary schools or colleges.

529 Plans
These state-sponsored savings plans allow you to stash up to $11,000 a year for each of your children. You can choose from a variety of investment portfolios, and in some states you may even deduct your contribution on your state income tax return. Withdrawals are tax-free if used for higher education expenses.

Prepaid Tuition Plans
Some states offer plans that let you lock in tomorrow’s tuition at today’s rate for designated schools. If your child decides to go elsewhere, the money you invested in the prepaid plan may be refunded to you, minus a fee.

Qualified US Savings Bonds
You can set aside up to $30,000 a year in savings bonds, and the earnings are exempt if you use the funds to pay higher education expenses, if you don’t exceed the income limitations.

UGMA/UTMA Accounts
The rules for these accounts are simple: you can set aside $11,000 and invest in anything. But here’s two reasons why this simple solution may not be best:

  1. The funds are considered the child’s property under financial aid formulas. That can affect your child’s eligibility for financial aid, since 35 percent of the child’s assets count toward college costs, vs. only 6 percent of your own assets. And
  2. When your child reaches the age of majority in your state, the money is theirs to do with as they please. Ouch!

Tax Credits
Some nifty tax credits are available if you have children in college. The Hope Scholarship credit gives you a tax credit of $1,500 per child for tuition during the first two years of college. The Lifetime Learning Credit will whack another $1,000 from your taxes for each year after that. But these credits begin to phase out if your income is over $41000 ($83,000 on a joint return.)

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