Types of Education Accounts
Section 529 Plan
The advantage of a 529 plan is that anyone can contribute money into the 529 plan to fund your child's future education. While other education plans take control away from you when the child reaches a certain age, with the 529 plan, you will always remain in control of the money. You decide when to withdraw money to use for education expenses. Those withdrawals that count as education expenses for post K-12 education will be excluded from gross income for federal income tax purposes. Even if federal income taxes are issued, it will be in your child's tax bracket and give a lower rate.
Coverdell Education Savings Accounts (formerly Education IRAs)
Although contributions are not tax-deductible, earnings are income tax-free. A maximum amount of $2,000 can be invested in your child each year until the age of 18. Any family member can contribute to the Coverdell Education Savings Accounts but the total amount of contribution each year cannot exceed $2,000. Family members with income in excess of $95,000 for single people and $190,000 for married couples cannot contribute to this account. Any withdrawal for education expenses will not have income tax. An added advantage is that the money can also be used for K-12 education expenses. However, if these funds are not used before the child is 30, the account will be liquidated and income tax will be levied on earnings. This can be prevented by transferring the account to another child, even the children of the previous account holder.
UGMA/UTMA
Uniform Gifts/Transfers to Minors Act (UGMA or UTMA accounts) allows the parent to transfer any assets (stocks, bonds, real estate) to their child. The earnings will be taxed in the child's tax bracket unless earnings are over a certain limit and the child is younger than 14. Using this type of plan takes the parent's control of the funds out as soon as the child reaches 18 as the assets will be legally theirs. Eligibility for financial aid might be reduced as the child holds those funds instead of the parents.
Retirement Plan Loans
The loans taken out of your retirement plan can be taken out to pay for education expenses without incurring income tax. However, you must be younger then 59 years and 6 months and you will have to pay interest on top of replacing those funds in your retirement account. The disadvantages of this choice for education is that you will be essentially depleting your own retirement funds and basically dividing your previous account into two accounts supporting two different causes. You will not be seeing as much money as if you had kept all your funds in the same account.
Pre-Paid Tuition Programs
Although many of these programs are forms of 529 plans, those pre-paid tuition programs that aren't allows parents to pay for part or all of the future tuition now. The investment will grow at an equal rate to inflation in current tuitions so that it is guaranteed to be the same proportion that you paid for. Earnings will be taxed at the child's rate at time of withdrawal. This is a good plan for high income families that do not need financial aid as it reduces the child's chance for financial aid.
Home Equity Loans
For those parents who have assets in the form of houses as opposed to cash, home equity loans is a viable option, giving income tax deductions on interest on the loan. The main disadvantage is that you will be burdening yourself with another mortgage payment in the future.
Bonds
For those families in the low to middle income bracket, Government series EE savings bonds can be used as the interest will be tax free just as long as they are used to pay for tuition in the year that they are redeemed..
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