Saving money for our children's higher education is a little like walking through a mine field, which plan best suites our needs. President Bush has just signed the Pension Protection Act, the act outlines strengthening the financing rules for defined benefit plans. The main problem I found with this act is that the Pension Protection Act eliminates the 2010 sunset provision for tax-free withdrawals from the Section 529 tuition savings plan.
This plan was created in 1996 and it allows after-tax income (which means it will not be taxed there after) to be invested in state-sponsored plans and to grow free of federal and state taxes. Fortunately, the Economic Growth and Reconciliation Act of 2001 states that as long as the 529 money is used for college expenses that income earned can be withdrawn free of federal and state taxes. But the tax-free withdrawals are set to expire at the end of the year 2010. If and when that happens the distributions from the plan are taxable, albeit at the student rate.
Most experts are now saying that more 529 options only represent more ways to make the same mistake of investing in these plans. Your investments are locked into specific rules just for a tax benefit and the plan is completely lacking in flexibility. The Coverdell Education Savings Account is another alternative to Section 529. Both plans are similar in that they allow money to grow tax deferred. The Coverdell Education Savings Account may also be put towards primary and secondary education.
If your children qualify for financial aid and you want to use the 529 plans then put it in your name. You really don't want the plan to be considered your child's assets when financial aid calculates an aid package. For those high-income parents who probably won't qualify for financial aid, it would make sense to place the Section 529 under you child's name to take advantage of the lower tax rate.
Experts recommend purchasing a Series I United States savings bond with the child's name on it. It can be used for higher education and the interest income is exempt from federal income taxes. Another option for a high-income family is custodial accounts – Uniform Transfers to Minors Account (U.T.M.A.) or Uniform Gifts to Minors' Accounts (U.G.M.A.). These accounts are a way to shift assets to your children. You could also set up a complex trust which would include restrictions so that once the child turns 18 they would not be able to spend all the money on a car or sound system.
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