If you're waiting to start saving for your child's education - don't.
Besides the fact that it's never too early to begin stashing away money for a college education, the here-and-now is a great time to take hold of some of the tax benefits that can go along with your saving efforts.
Two of the most tax-savvy ways to save for your kid's future can be found in Coverdell Education Savings Accounts, or ESAs, and Qualified Tuition Plans, known as QTPs.
The main attraction for these programs is the same that draws you to your qualifying retirement account: distributions from ESAs and QTPs are tax-free when withdrawn and used for your child's education.
There are several rule changes, effective as of 2002, that translate into both increased savings and more options:
- The contribution limit for Coverdell ESAs, previously called Education IRAs, has been raised from $500 to $2,000 a year, making the accounts a much more valuable savings tool.
- You can now contribute to both an ESA and a QTP within the same year's time. Previously, you weren't allowed to put money into an ESA and a QTP for the same child.
- QTPs offer many more investment choices than before, and if you aren't crazy about the fund you're in, you can roll the funds into a different fund once in any 12-month period. In 2001, you could only change funds when you transferred the account to a different beneficiary.
- Private and religious institutions are now allowed to establish QTPs, expanding your choices of prepaid tuition plans. The programs, called qualified state tuition plans last year, have been renamed to reflect this change.
- While there are still adjusted gross income (AGI) limitations on who's allowed to contribute to ESAs, the AGI range for those filing jointly has been raised.
There isn't one way of saving that is, hands down, better than the other. As a rule, education savings should be invested - you'll earn a better return when compared to the fairly low interest rates offered by bank savings accounts. But the "right" investment mix depends on the length of time until the beneficiary goes to college.
The pre-tax earnings and non-taxable distributions offered by QTPs and ESAs can make a difference. And, many states offer a deduction or credit for residents who contribute to that state's QTP. (For more information on QTPs, visit http://www.savingforcollege.com.)
If you're planning to apply for need-based loans, grants, or scholarships, "how" you save can be just as important as how much you save. Distributions from prepaid tuition plans, offered in QTPs, count as the student's income, which can reduce or eliminate financial aid. The same goes for ESAs. They count as the student's assets on financial aid applications.
The right choice for you might actually be a combination of two (or more) of the available savings methods. You should investigate the options (and the financial aid consequences), and choose the method(s) that will help you reach your savings goal for your child's education.
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