9 ways to save for college in 2009

As a new year dawns, Americans face a host of new economic challenges. Here are nine great moves you can make during a difficult time to save for a college education in 2009.

1. Take advantage of low stock values 
With the market at depressed levels, now could be a great time to cash out from a taxable investment account and move the money into a 529 plan or Coverdell education savings account. In these accounts, future earnings and growth are tax-deferred and distributions are tax-free when used for qualifying college expenses.

If the sale of your existing investments results in a net capital loss, you may be able to offset as much as $3,000 of ordinary income on your tax return. If you've already established a 529 account or ESA and determine that it is worth less than your contributions, talk to your tax professional about the possibility of liquidating the account and claiming the loss as a miscellaneous itemized deduction on your Form 1040.

2. Steer clear of the ‘Kiddie Tax’ 
If your child has a Uniform Gift to Minors Act account or Uniform Transfer to Minors Act account that has appreciated in value and you're thinking about selling the investments in that account during 2009 -- perhaps to pay college bills -- be mindful of the tax and financial-aid consequences.

Under the "Kiddie Tax," a child's 2009 unearned income in excess of $1,900 is taxed at the parents' marginal tax rate. The age requirements have changed so that college students as old as 23 are now at risk.

One strategy for avoiding the Kiddie Tax is to spread out their gains over multiple years and avoid triggering more than $1,900 in investment income in any one year. Another possible remedy: Children ages 18 to 23 escape the extra tax if their wage income exceeds one-half of their total support. Calculating "support" can get tricky, so you should discuss this with a tax professional.

The recognition of gains also affects a college student's financial aid eligibility, as income of a student above a $3,750 allowance is assessed at a 50 percent rate in the federal aid formula.

3. Grab a state tax break 
If you live in one of the 35 states that provide their residents with a state income tax deduction for contributions to a 529 plan, you have a great opportunity to reduce your taxes and save for college at the same time.

Even with a child in college or close to college age, it can make sense to open a 529 account now and use it to pay a tuition bill due next month.

Be sure you understand the deduction rules in your state, including limits on the amount you can deduct, contribution deadlines and any restrictions relating to the account setup. Most states require you to invest in your state's own 529 plan to qualify for a deduction, but residents in five states -- Arizona, Kansas, Maine, Missouri and Pennsylvania -- can deduct contributions they make to any state's 529 plan.

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