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Don't dismiss need for education fund

Dear Dr. Don,
My husband and I would like to start saving for our 1-year-old daughter's future. I would hate to contribute money to a 529 savings account -- what if she decided that she didn't want to attend college and we ended up getting taxed on it? Are there any other options?
-- Lori Long-Range

Dear Lori,
I don't think you should dismiss investing in a Section 529 Qualified Tuition Plan just because your daughter may decide not go to college. While there is a 10 percent penalty tax and income taxes due on the earnings for non-qualified distributions, the original contributions are not subject to penalty or taxes if they are withdrawn as non-qualified distributions.

In addition, there is some flexibility in changing the beneficiary on the account and some exceptions to the penalty. Learn more about Section 529 accounts by reading " Smart ways to pay for college" on Bankrate, and check out college money expert Joe Hurley on SavingforCollege.com.

I think a reasonable alternative is to save for her college in IRA or Roth IRA accounts set up for you and your husband, assuming you're eligible to contribute to these accounts. Qualified education expenses can be withdrawn without penalty. Income taxes are due on distributions out of an IRA that was funded with tax-deferred contributions. Income taxes on distributions out of the Roth IRA are only due on the investment earnings, not the original contributions.

" An IRA Primer" on the SmartMoney Web site discusses these early distributions and their tax impact in easy to understand terms.

Another alternative is to buy savings bonds in your name with the intent of using them for your daughter's college education. You can defer any income tax due on the bonds until you redeem them or they mature. If you redeem bonds for qualified educational expenses, there's no income tax due on the investment earnings.

One drawback to this approach is that the ability to participate in the program is phased out based on the parent's modified adjusted gross income. TreasuryDirect explains the " Education Tax Exclusion" on its Web site.

There are other alternatives as well, like Coverdell Education Savings Accounts, or CESA, but you'll have the same beneficiary issues in the CESA that you have with a Section 529 account.

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