Available college savings plans
Not all savings plans are created equal, and what works best for your neighbor may not work well for you. Listed below are some of the major differences you’ll find in the college savings plans.
| Savings Vehicle | Tax Issues | Possible Contributors | Possible Uses | Taxed Individual (if applicable) |
| 529 plans | No tax is 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 is paid on interest earned until distributions are made. Currently, distributions used for qualified educational expenses are tax-exempt. | No relationship test. Must satisfy the 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 is 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 is paid yearly on income earned within the account. No additional tax is 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 is paid yearly on income earned within the account. No additional tax is assessed when you take distributions for any reason. | Trust grantor (the donor) only. | All expenses. | In the years in which distributions are made, the person to whom the distribution is made, but since there are no tax deferrals, there can only be income earned in the same year as the distribution. 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 is 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. |
Identifying wasteful spending
One of the first ways to start saving — or start saving more — is to cut out what I call “wasteful spending.” I do not advocate cutting back on necessities — or even all the fun “extras” — in your college-saving quest. But this stuff is far from necessary — and most of it isn’t fun:
- 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.
- 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.
- 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, magazine, and online subscriptions that you just haven’t gotten around to canceling: Either read them or cancel them.
- 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.