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Dr. Don TaylorCollege fund for grandson


Editor's note: The Pension Protection Act of 2006 signed into law by President Bush on Aug. 17, 2006 removes the 2010 expiration of the 529 tax exemption. Withdrawals from a 529 plan will continue to be completely tax-free when used for college. Read more.

Dear Dr. Don,
I would like to start a college fund for my grandson, who is 8. What would you recommend: bonds, a savings account in his name; etc. etc? I want to be sure it is secured for his education. Thank you.
-- Cordella Collegiate

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Dear Cordella,
I think you should choose a Coverdell Education Savings Account, or CESA, a section 529 college savings plan, or a section 529 prepaid tuition plan. All three types of college savings accounts offer tax advantages when investing for college.

Start out by deciding whether you'll be investing a lump sum, contributing over time or both. An automatic investment plan can make it easy to set aside money on a regular basis.

The Coverdell Education Savings account is limited to a total contribution of $2,000 per year, per beneficiary. There are some modified adjusted gross income, or MAGI, limits on the contributor, from IRS Publication 970, Tax Benefits for Education.

If your modified adjusted gross income is less than $110,000, or $220,000 if filing a joint return, you may be able to establish a Coverdell ESA to finance the qualified education expenses of a designated beneficiary. For most taxpayers, MAGI is the adjusted-gross income as figured on their federal income tax return.

You can open a CESA account with a mutual fund, a brokerage firm or a bank. You'll have your choice of investing in stocks, bonds, money market instruments or certificates of deposit. Keep an eye on the sales loads, annual fees and expenses along with the risk associated with each investment. In general, you'll want to become more conservative with the investments as it gets closer to his matriculation date.

Section 529 plans come in two flavors, prepaid tuition plans and college savings plans. You don't have to use the plans offered by your grandson's (or your) state of residence, but there can be important tax advantages in using plans offered by his (or your) state.

The NASD provides an excellent overview of the different approaches to college savings in: Smart Saving for College - Better Buy Degrees 529 Plans and Other College Savings Options. It includes a warning about the sunset provisions in the current law excerpted below:

Caution! The law exempting qualified withdrawals from federal income tax expires on Dec. 31, 2010. Unless Congress and the president take action to extend the provisions of this law, withdrawals from 529 plans will not be tax-free beginning in 2011. Keep this in mind if you have younger children who will be in college after 2010.

Since the sunset provision is only four and a half years away and your grandson's matriculation date is nine to 10 years away, changing tax laws will influence the tax advantages of the account. A CESA account isn't subject to the sunset provisions.

The NASD guide also has a Section 529 expense analyzer that can help you estimate the expenses associated with a Section 529 account and what to look for in a CESA account.

You have more investment options with a Coverdell Education Savings Account, but it won't come with the guarantees of a prepaid tuition plan or the contribution potential of a section 529 account. Talk to the boy's parents about their plans for his college savings since any contributions they make into a CESA reduces your ability to contribute funds.

Finally, in reviewing section 529 plans you should work your way through Bankrate's 529 savings-plan estimator and savingforcollege.com's College Costs 101, 201 and 301. You'll get a real education and have the ability to review the programs offered by the states.

You also should take a look at the multiple college financing stories available on Bankrate.

-- Updated: Oct. 18, 2006




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