There are numerous options available to invest savings for a child's education:

  • State-sponsored "529" college savings plans: State-sponsored 529 plans are investment vehicles that allow you to make tax-free deposits for your child's future college costs. Depending on your plan you can either enroll directly through the state overseeing the plan or you may need to invest through a brokerage firm. You can choose between a variety of investment options for your funds according to your risk tolerance and investment time horizon (when you need to access those funds). Anyone can contribute to the plan (i.e. grandparents, extended family) and the earnings in the plan grow tax-free. You can then withdraw money tax-free from the account when it comes time to pay for school-related expenses. However if you use funds for non-college related expenses you will have to pay tax on the earning and a 10% penalty. If you're not satisfied with your plan's performance you can switch 529 plans once every 12 months. For more on this read, Don't Forget the Kids: Save for Their Education and Retirement and Choosing the Right Type of 529 Plan.
  • Coverdell education savings accounts (ESA): You can contribute $2,000 each year (for each of your children) to a Coverdell ESA to help pay for your child's elementary, secondary school and college costs. You choose how your money is invested; the money you earn on your investment grows tax-free and you do not have to pay taxes when you withdraw money from the account for qualified education-related expenses. There are income limits to be able to qualify to contribute to a Coverdell ESA. ;Anyone whose income qualifies can contribute to an account (i.e. grandparents, family friends).

  • Prepaid tuition plans: With a prepaid tuition plan you pay into an account either managed by a state or a specific college. Your funds are bundled with other contributors and invested to earn a return, which will hopefully outpace the rising cost of college tuition for the school or state which you have selected for your child to attend. As long as you withdraw money from the plan to pay for qualified school-related expenses your withdrawal is exempt from federal taxes and perhaps from state taxes as well. However if you withdraw the money for non-college related expenses the funds will be taxed and you will have to pay a 10% penalty on money your investment earned. And if your child chooses to attend a different school (if you're paying into a school-specific plan) or an out-of-state college (if you're paying into a state-managed plan) you may not be able to recover all of the money you have invested.

  • Custodial accounts: The Uniform Gifts to Minors Act (UGMA) and the Uniform Transfers to Minors Act (UTMA) accounts allow you to deposit up to $10,000 tax-free each year in an account to be used for your child's education. The account is in your child's name but managed by you until the child reaches 18 or 21 (depending on your state's law regarding the "age of majority"). While the child is a minor, money in the account(s) can be used for college or any other expenses for your child; however the account becomes the property of your child when s/he reaches the legal age of adulthood in your state and at that point can use the funds for any purpose, school or not.

  • Series EE Savings Bonds:U.S. Treasury EE savings bonds are backed by the federal government and guarantee a fixed rate of return. Bonds can be redeemed to pay for qualified college expenses and the bondholder does not have to pay income tax on the interest earned. There are income limits to qualify for the tax exemption and the bondholder must be at least 24 years old. You are limited to purchasing $5,000 in EE bonds in one year; you can purchase EE bonds in a variety of denominations (between $50 and $10,000) and buy them online through the U.S. Treasury's Treasurydirect.gov website.

This question was answered by Katie Adams.

  1. Are UTMA accounts escheatable?

    Like most financial assets held by institutions such as banks and investment firms, UTMA accounts can be escheated by state ... Read Full Answer >>
  2. Are Cafeteria plans subject to FICA, ERISA or FUTA?

    Cafeteria plans are employer-sponsored benefit plans that provide both taxable and nontaxable, or qualified, benefit options ... Read Full Answer >>
  3. What is the annual contribution limit for a 529A account?

    Contributions to a 529A plan are limited up to the annual gift tax exclusion limit, currently $14,000 a year in after-tax ... Read Full Answer >>
  4. Can minors invest in mutual funds?

    A mutual fund can be opened under the name of a minor through a custodial account overseen by a guardian. The custodian holds ... Read Full Answer >>
  5. Are Cafeteria plans taxable?

    Whether the benefits you receive through your employer-sponsored cafeteria plan are taxable depends entirely on which benefits ... Read Full Answer >>
  6. Why is the Cayman Islands considered a tax haven?

    The Cayman Islands is one of the most well-known tax havens in the world. Unlike most countries, the Cayman Islands does ... Read Full Answer >>
Related Articles
  1. Personal Finance

    Is An Ivy League Degree Worth It?

    In 600 B.C. Aesop determined that a bird in the hand was worth two in the bush. Warren Buffett claims that this axiom can be used to determine the most valuable uses of capital. In this article ...
  2. Taxes

    How & Where to File Form 1040 (And Which Version)

    All taxpayers need to know three things when filing a 1040: which form to use, how to file and where to file. After reading this, you'll know all three.
  3. Savings

    Should You Look at 529 Plans Outside Your State?

    529 savings plans are not restricted by geography. So if your in-state offering has high fees or poor investment choices, look elsewhere.
  4. Retirement

    Pros and Cons of Deferred Compensation Plans

    Learn about the pros and cons of non-qualified deferred compensation (NQDC) plans, including the flexibility of non-ERISA plans and the potential for forfeiture.
  5. FA

    Paying for College: Utilize These Top Hacks

    Saving money for college is difficult for many families, but it doesn't have to be. Here are some overlooked hacks to save money on college costs.
  6. Savings

    How To Set Up A Trust Fund If You're Not Rich

    You don't need to be worth millions to create your own trust fund. Learn how your money can be handled in the event of your death.
  7. Economics

    What China's New Policy Means for Business

    Now that China has eliminated its one-child policy, how will the new policy impact businesses?
  8. Taxes

    10 Money-Saving Year-End Tax Tips

    Getting organized well before the deadline will curb your frustration and your tax liability.
  9. Professionals

    Parents: Avoid This Retirement Savings Mistake

    Parents should make saving for their own retirement a priority over helping with their children’s college costs.
  10. Mutual Funds & ETFs

    A Review of the Vanguard 529 College Savings Plan

    Read this introduction to the Vanguard 529 College Savings Plan and the features and benefits that it offers as well as comparisons with other plans.
  1. Student Loan Forgiveness

    Under certain circumstances, federally backed student loans – ...
  2. Taxes

    An involuntary fee levied on corporations or individuals that ...
  3. 529 Plan

    529 is a category of plans that provide tax advantages when saving ...
  4. Wealth Management

    A high-level professional service that combines financial/investment ...
  5. Direct Consolidation Loan

    A loan that combines two or more federal education loans into ...
  6. Post-9/11 GI Bill

    A United States law that provides benefits to military veterans ...

You May Also Like

Hot Definitions
  1. Take A Bath

    A slang term referring to the situation of an investor who has experienced a large loss from an investment or speculative ...
  2. Black Friday

    1. A day of stock market catastrophe. Originally, September 24, 1869, was deemed Black Friday. The crash was sparked by gold ...
  3. Turkey

    Slang for an investment that yields disappointing results or turns out worse than expected. Failed business deals, securities ...
  4. Barefoot Pilgrim

    A slang term for an unsophisticated investor who loses all of his or her wealth by trading equities in the stock market. ...
  5. Quick Ratio

    The quick ratio is an indicator of a company’s short-term liquidity. The quick ratio measures a company’s ability to meet ...
  6. Black Tuesday

    October 29, 1929, when the DJIA fell 12% - one of the largest one-day drops in stock market history. More than 16 million ...
Trading Center