529 savings plans. College savings plans are more flexible than prepaid tuition plans. In most savings plans, you can choose to go to school in any state regardless of where your 529 savings plan is from, according to Savingforcollege.com.
These plans generally offer a number of investment options including stock mutual funds, bond mutual funds and money market funds. The can be used to pay for all "qualified" expenses, including books, room and board and fees.
There are a few caveats however. Unlike a prepaid tuition plan, investments in a college savings plan are subject to market risks, and there is no lock on future college costs.
Both prepaid and 529 savings plans provide a "double whammy" effect regarding tax breaks. That's because not only are earnings tax-deferred, but they are also tax-exempt when distributed for qualified educational expenses.
"The big tax advantage is the money grows tax-free," says Kay Bell, a Bankrate tax expert and blogger. "You don't get an immediate tax break, but you get an eventual tax break."
While 529 plans are a great way for parents to save for their children's education, they are not deductible on federal income tax returns. However, contributions to a 529 plan may be deductible on your state income tax return.
"Some states will give a tax break in either the form of a deduction or a credit," says George Saenz, a CPA and Bankrate's "Tax Talk" expert. "You have to look into it based on the state you live in."
Learn more about 529 plans at Savingforcollege.com.
5. Retirement savings for individualsTraditional IRAs. Individual retirement accounts, or IRAs, are personal savings plans that offer tax advantages as you save for retirement.
Depending on your income, you may be able to take a tax deduction for some or all of your contributions to a traditional IRA. You pay taxes later during retirement, when making withdrawals from your account.
The amounts in these accounts generally are not taxed until you take a distribution.
Withdrawals made prior to age 59 1/2 could be subject to a 10 percent penalty tax. You also may owe a hefty excise tax if you do not begin withdrawing minimum distributions by April 1 of the year after you reach age 70 1/2.
For 2008, you generally can contribute up to $5,000 to a traditional IRA -- $6,000 if you are 50 or older and making catch-up contributions.
Roth IRAs. Unlike traditional IRAs, you can't deduct contributions to another type of IRA -- the Roth IRA.However, the benefit of Roth IRAs is that the contributions are made with today's after-tax money as opposed to some future tax rate, which may be higher. You get the benefit at the time you take withdrawals, since qualified distributions are tax free.
Unlike with traditional IRAs, contributions can be made to your Roth IRA after you reach age 70 1/2 and you don't have to withdraw money from your Roth IRA at all during your lifetime.
For 2008, you generally can contribute up to $5,000 to a Roth IRA -- $6,000 if you are 50 or older and making catch-up contributions. If you wish to contribute to both a Roth and a traditional IRA, the total contribution amount cannot exceed these limits.