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Saving for College, Part II

March 6, 2009

by Emily

Continuing our theme from yesterday, today's blog post centers on more options for saving for college.  Yesterday, we discussed 529 plans, popular college savings vehicles that have been battered by recent financial troubles.  If you're considering saving for college but are not sold on a 529 plan, the most common alternatives are discussed below.

Coverdell ESA. Coverdell Education Savings Accounts are similar to 529 plans in most respects, but do have their own benefits and drawbacks. Rather than being sold by a state, they are sold by banks and brokerages, which can charge their own management fees. Because there aren't any state ties, there aren't any residency limitations, though there also aren't any state tax breaks for enrolling in a Coverdell ESA.

Coverdell accounts allow more flexible investment options and unlimited changes to investments. They can also be used to pay for high school and elementary school expenses, in addition to college costs. Otherwise, the expenses Coverdell and 529 plans can be used for are roughly the same: tuition and fees, books and supplies, room and board if over half-time, and other qualified educational expenses.

One major limitation to the Coverdell ESA is the $2,000 annual contribution cap. This is the limit per account holder, not per contributor. Additionally, individuals must have an adjusted gross income of $110,000 or below to contribute, and $95,000 or below to contribute the full $2,000. Coverdell accounts are held in the beneficiary's name, so they can hurt the student on the FAFSA. They also must be used or cashed out by the time the beneficiary turns 30, and they go to the beneficiary no matter what, while 529 plans can be given back to the parent in charge of the account if the student chooses not to go to college.

Roth IRA. The Roth IRA, typically used as a retirement account, can also be used to save for school. As long as you're withdrawing contributions, rather than earnings, there is no penalty if you are using the money from your IRA for educational expenses. However, a college savings plan might be the better way to go if you're setting up an account specifically for your student (especially since contributions to a Roth IRA must come from income the beneficiary earned from working), and dipping into your retirement funds to pay for college is widely regarded as a less than ideal choice by financial experts. But if you choose to take it, the option is there.

UTMA. The Uniform Transfer to Minors Act allows assets to be given as gifts to minors without the establishment of a trust. While the options explored up to this point have been savings accounts or investments, UTMA covers everything, including property. An adult manages these assets in a custodial account until the owner reaches the age of 18 or 21, depending on the state. In the meantime, the funds in the account can be used to benefit the child, including taking care of educational expenses. Once the owner reaches the age of majority, the assets are theirs to use as they please. This can mean paying for school, or it can mean making less desirable financial choices.  Since these assets belong to the student, they would count against them for student financial aid.

Government Bonds. While typically regarded as the province of grandparents, government savings bonds (Series EE is the most common) are also an option for paying for college. Bonds can be purchased online or at banks, and redeemed later for cash. As opposed to stock market-based savings plans which can lose big during crashes, government bonds are going to continue to grow as long as there's a government to honor them. And if there's no longer a United States government, well, you might have more to worry about than paying for college.

Also, since no rules state that a savings bond must be redeemed for college costs, the money can be used towards paying off student loans, covering college living expenses...or partying it up during spring break in Mexico.

While EE Savings Bonds grow at a steady rate, they do grow very slowly. You're also limited to a purchase of $5,000 per calendar year. Since they're such a safe bet, they can be great gifts for high school students, but a market-based option might be a better way to grow savings and maximize returns for younger children.


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