The challenge today is that there are so many options for saving, and one size does not fit all. Some of the vehicles to implement your college planning strategy include:
Cash & Cash Equivalents
CDs, money market funds, short-term bonds or bond funds, and savings accounts are good options when you'll need the money soon for college, within five years or less.
U.S. Savings Bonds
The interest earned is free of federal tax if the money is used to pay for qualified college expenses, and if your income qualifies. Be certain to check about issuing requirements.
Coverdell Education Savings Accounts
You can now contribute up to $2,000 a year to what was formerly called the education IRA, though some income restrictions remain. Earnings are federal income tax-exempt as long as they are used for qualified education expenses, which now include K-12 private school costs.
Pre-paid State Tuition Plans
Some states offer programs in which you pay for tuition in advance with the promise that tuition costs will be covered when your child enrolls regardless of how much tuition climbs between now and then. It's a good option for conservative investors or in the event that tuition costs increase dramatically. Some plans are limited to schools within state and do not include private universities.
529 College Savings Plans
Individual states administer these plans, while investment management is usually outsourced to an investment firm or mutual fund company. These plans offer some unique features, which vary by state. Some plans allow:
- Up to $12,000 in contributions annually
- Investor control when the student reaches the age of maturity
- Tax-deferred growth
- No income restriction to open a plan
- No age limit to open a plan or to start or complete withdrawals
- Qualified withdrawals are federally tax free through the year 2010; some states allow limited state income tax deductions for in-state contributions
- Ability to change beneficiaries or account owners as needs change
You can invest in anything you choose—stocks, mutual funds, bonds, real estate—with the potential of earning a higher return than some other college investment options. Income from the assets is taxed at your rate. You can minimize any capital-gains taxes on the investments by gifting the property to your child when it's time for college and having your child sell the property, though you could face gift taxes.
You can choose your investments. Earnings grow tax deferred, and early withdrawals are not subject to penalties if used for college expenses. Earnings are subject to income tax, however.