Traditional methods of saving for college are still popular, but there are some newer and more creative methods of saving, as well.
You really should sit down with a financial advisor, who will assess your financial situation and recommend a plan that best suits your situation. So you know what the advisor is talking about, some information about other options for saving for college is given in the following sections.
In order to cash in on the income tax exemption of EE bonds, they can only be used for educational expenses for you, your spouse, or your dependent children. The bonds can be used to pay for tuition, room and board, and books.
A method of saving for college that's gaining in popularity is utilizing EE Bonds. These bonds are special because the interest accrues on them from the time the bonds are purchased until they are cashed, with the proceeds used toward college exempt from federal income tax liability. This is a beneficial tool, but you should know that it's not available to everyone.
A person over the age of 24 must purchase the bonds in the name of the parents of the child for whom the money is earmarked—not in the child's name. And the bonds must be held for at least five years before they can be used for college costs. That means you can't go out and buy them when your child is 17 and expect to use them to pay for college costs.
When you cash in the bonds to pay for educational expenses, the entire interest amount is tax free, provided your joint household income is less than $79,650. The amount is pro-rated up to a maximum of $109,650 of family income, and, once you're over $109,650, the accrued interest is taxed.
EE bonds can be a nice supplement to your college savings, but not a practical means of funding an entire college education. If your child doesn't go to college, the bonds remain in your name.
Uniform Gifts to Minors Act (UGMA) Accounts
These are older style accounts that are set up to lower the income tax liability that individuals pay for funds in their children's names. Funds set aside for college, or given as gifts to your children, are placed into an account in the child's name under the Uniform Gifts to Minors Act. The funds belong to the child. Since the child is a minor, however, the funds must have a custodian—usually a parent. The funds accumulate and are invested, with the child earning investment income. The nice thing about these kinds of accounts is that the first $750 of investment income the child earns is not taxed, and the next $750 is taxed at the lowest tax bracket. After that, the rate increases and is paid at the parents' tax rate. After age 14, the rate is always taxed at the rate of the child's tax bracket.
Don't Go There
Life insurance is not a good investment for a college account. Neither are limited partnerships or tax deferred annuities. These are long-term investments that aren't suitable for college savings. If your financial advisor recommends any of these investment tools, run and find another advisor.
A possible downside of these funds is that the money belongs to your child. If Rob decides to buy a motorcycle and ride through Europe instead of going to college, as long as he's no longer a minor, you can't stop him from taking his “college” money with him. It's a good idea to only invest enough in these types of funds to get the income tax advantage, and put the rest of your child's college money somewhere else.
The custodian of a UGMA account can set it up as a savings account in the local bank, and change it to a brokerage account as the account grows. You can even buy stocks or bonds with the money, but not unless you know what you're doing.
Gift tax limitations dictate that a maximum of $10,000 a year can be placed in a UGMA account. That amount can be doubled if a couple is gifting.