529 and Other College Savings Plans For Dummies
When you're ready to start saving for college, check out the different savings plans available so you pick the one best for you. Find out how you can cut wasteful spending from the budget to contribute more to your college saving plans, and be aware of provisions affecting the conditions of the 529 and Coverdell accounts.
Available College Savings Plans
Do your research when you're deciding on a college savings plan — not all savings plans are created equal. What works best for your neighbor may not be the best choice for you. Listed below are some college savings plans and the major differences that you'll find among them:
|Savings Vehicle||Tax Issues||Possible Contributors||Possible Uses||Taxed Individual (if Applicable)|
|529 plans||No tax paid on interest earned until distributions are made. Currently, distributions used for qualified educational expenses are tax-exempt.||No relationship or income-limitation test.||Any expenses you choose. However, distributions used to pay for nonqualified expenses are subject to income tax on the earnings portion, plus a 10% penalty.||Designated beneficiary.|
|Coverdell accounts||No tax paid on interest earned until distributions are made. Currently, distributions used for qualified educational expenses are tax-exempt.||No relationship test. Must satisfy income-limitation test.||Any expenses you choose. However, distributions used to pay for nonqualified expenses are subject to income tax on the earnings portion, plus a 10% penalty.||Designated beneficiary.|
|Series EE and Series II savings bonds||No tax paid on interest earned if redeemed bonds are used for qualified educational expenses.||Must satisfy relationship and income-limitation tests to qualify for tax-free treatment of interest upon redemption of bonds.||Any expenses you choose. However, only the portion used for qualified educational expenses is tax-free.||Bond owner.|
|Personal investment accounts||Tax paid yearly on income earned within the account. No additional tax assessed when you take distributions for any reason.||You contribute to your own account or may make gifts into someone else's.||All expenses.||Account owner.|
|Trust accounts||Tax paid yearly on income earned within the account. No additional tax assessed when you take distributions for any reason.||Trust grantor (the donor) only.||All expenses.||In years in which distributions are made, person to whom the distribution is made. In all other years, the trust pays the tax.|
|Retirement accounts||Tax deferred until you take distributions. Early distributions may also be subject to an additional penalty.||Account owner only.||Any expenses you choose. However, distributions used to pay for nonqualified expenses are subject to income tax on the earnings portion, plus a 10% penalty.||Account owner.|
|Home equity||No tax owed if you refinance your house and use some or all of your equity to pay for college expenses. If you sell your house, you may be liable for a capital gains tax in some situations.||Anyone may buy you a house or make payments against an existing mortgage; generally, only the homeowner actually does.||All expenses.||Homeowner.|
Eliminate Wasteful Spending to Save More for College
Trimming the fat from your budget is one way to start saving, or start saving more, for college. You can do this without cutting out the necessities or sacrificing the fun "extras." Take a look at the following examples of wasteful spending and how you can cut it out of the family budget:
Checking-account minimum-balance penalty: Get the balance up or switch banks.
Insufficient-funds penalty: Quit with the bounced checks.
Credit-card interest: Start paying down that balance.
Over-limit credit-card fees: Don't push the limits.
Late-payment fees for credit cards, car loans, utilities, and so on: Get that check in the mail a few days sooner or go with the automatic debit option that everyone is pushing these days.
Late charges on video rentals: Suck it up, get in the car, and return the movies on time.
Health-club dues to a club you haven't attended for over a year: Either get on the exercise bike or get on the phone and cancel your membership. If you're not using the gym, the only thing getting thinner is your bank balance.
Newspaper and magazine subscriptions that you just haven't gotten around to canceling: Read or dial.
Hitting the coffee shop every morning: Get up five minutes earlier, three times a week make coffee at home, and save ten bucks.
Going out to lunch every day: Embrace the brown bag a few times a week.
Section 529 and Coverdell Account Sunset Provisions
Although the existence of Section 529 plans and Coverdell Education Savings Accounts seems fairly established, many of the specific regulations governing them aren't. The following list describes some of the provisions regarding these college savings plans set to revert to older law on January 1, 2011.
Income on distributions that is currently tax-exempt will become taxable income to the designated beneficiary.
Contributions to Coverdell accounts will revert to a maximum of $500 per year.
Distributions used to pay primary and secondary school educational expenses will no longer be qualified under Coverdell rules.
The list of available relatives of your current designated beneficiary will narrow, excluding first cousins, aunts, and uncles.
You will no longer be able to contribute in any given year to both a Coverdell Education Savings Account and a Section 529 plan. You'll have to choose.
You won't be able to superfund a Section 529 plan after December 31, 2010, without triggering a gift tax. On January 1, 2011, the law is set to return to a maximum annual contribution of no more than the current exclusion amount ($11,000) per donor per beneficiary.