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There is also the Independent 529 Plan, a prepaid tuition plan operated by a consortium of more than 250 private colleges available to families in any state. It enables you to lock in future tuition at any of the participating colleges.
Beyond 529 plans, your primary college-savings options include Coverdell education savings accounts, or ESAs, U.S. savings bonds, and taxable mutual funds or banking products.
ESAs are sometimes recommended because, in spite of their low $2,000 per child annual contribution limit, withdrawals are tax-free for elementary and secondary school costs in addition to college costs. ESAs are also available from a wide variety of financial institutions, including banks, mutual funds and discount brokers.
However, federal laws will take away several of the advantages of Coverdell ESAs beginning in 2011, including the K-12 exclusion. Until Congress decides to fix that problem, I remain cautious about using them.
I am also reluctant to suggest taxable investments, such as mutual funds and bank certificates of deposit, as college savings vehicles. Why pay income tax on your college savings when an excellent tax-free alternative -- a 529 plan -- is so readily available?
Of course, the counterargument is that taxable investments can be used for any purpose without risk of penalty. By contrast, 529 withdrawals not used for college will be taxed as ordinary income and will incur a 10 percent federal penalty on the earnings portion.
However, with two children to educate -- and the ability to easily and at any time shift 529 funds between siblings -- you may view that risk as being fairly low.
You can also look to shelter a limited amount of taxable income by placing investments in your child's name through the Uniform Transfers to Minors Act, or UTMA. But the so-called "kiddie tax" can spoil that strategy if your child's investment earnings exceed a specified amount ($1,800 in 2008).
Taxable investments in your child's name will also significantly impact your child's eligibility for federal financial aid, whereas 529 plans have little effect on financial aid under current rules. Perhaps most importantly, you are legally bound to turn over control of UTMA assets to your child when he or she reaches the age of 18 or 21, depending on your state's laws.
Finally, ask yourself this question: Are you and your husband taking full advantage of employer matching in making contributions to your 401(k) plan?
If not, be sure to do that before committing those dollars to a college savings fund. Not only should you be thinking about your own retirement needs, but the employer match is a financial benefit that you will not easily make up in a 529 plan or any other investment.
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