Saving for Education

You have to save for your child’s education. The cost of education has been increasing significantly over the last few years and will continue to do so. You should plan on saving for your child’s education. Here are some of the options you can avail of:

Education Savings Accounts

This is a common method of saving for children’s education. It helps you save for different education expenses including elementary education and private schools besides college. It also offers many tax benefits. However there are certain limitations:

• Once the child becomes 18 years old, you can no longer fund the account.

• The annual contribution to an account is limited to $2000 per year. If the grandparents also start an account, then the annual contribution to both accounts combined cannot exceed $2000 per year.

• If for any reason the account is not used for the purpose it was set up, your child will receive the funds in the account but you will not get any refund.

• The account must be fully utilized by the age of 30.

• There is an eligibility criteria for opening an account – annual income of less than 100k for individuals ($200k for couples).

• Many benefits are subject to periodic renewal by the Congress.

529 Plans

A 529 plan is similar to an IRA or 4011. There are basically two types of such plans – prepaid and savings. These plans allow you to select various investment options and contribute to the account. They also have certain benefits when used for certain qualified educational expenses. Prepaid plans can only be used at in state schools while the savings plan can be used at virtually any school.

Savings Plan

Prepaid Plan

Can be used at virtually any school or collegeUse is limited to qualified in state schools and colleges
Does not secure a fixed tuition feeSecures a fixed tuition fee
The funds are not guaranteed and can lose moneyIn most cases, the funds are guaranteed by the state.
Educational expenses includes tuition, mandatory fees, books, room rent, etcEducation expenses include ONLY the mandatory fees and tuition.
The contributions are high but flexibleThe contributions are low but rigid.
There is no age limitAge and grade limits apply to most plans
There is no residency requirementsThe beneficiary or the owner must generally be a state resident.

U.S. Savings Bonds

US savings bonds are considered the safest investments. But they generally do not offer high returns. While the returns may be low, it is backed by the sovereign guarantee of the United States government. They also provide many tax benefits and redemption is tax free if used for tuition and fees. The tax laws are likely to change in 2010.

Other Financial Options

There are other certain non financial options that you can use to fund your child’s education. These include:

IRAs: You will have to pay a penalty if you make an early withdrawal but the penalty is waived if you withdraw to pay qualified educational expenses.

Lifetime Learning Credit: An individual can claim credit up to $2000 for tuition and fees for self, spouse and children. Those earning over a certain amount cannot avail this credit and it cannot be combined with the Hope Scholarship Credit.

Custodial Accounts: You can set up a custodial account for your child and use the funds to pay for anything that the child requires and not just educational expenses. However these accounts are taxed at your child’s tax rate.

Hope Scholarship Credit: Parents are eligible for a $2500 tax credit for the children’s tuition and fees for 2009 and 2010. The Congress can extend it beyond 2010. This credit cannot be combined with the Lifetime Learning Credit. Before availing tax credit, please check the prevailing rules as there are subject to constant changes.

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