Saving for education costs simplified with options

Jan. 1 ushered in a year of new tax laws and, with them, improved ways to save for your child's education, making it easier than ever to afford a college degree. While the tax-law changes may be hard to understand at first, there are some simple changes now in effect that can make a positive difference in how you invest for your child's education.

Coverdell accounts

Formerly known as an Education IRA, Coverdell education savings accounts are unique because they can be used to pay for elementary and secondary school expenses as well as for college. The accounts also can be used to fund items such as computers, school uniforms and even extended day-care costs. The annual contribution limit for these accounts has increased from $500 to $2,000 per child, and the deadline to contribute is now April 15 following the tax year.

Withdrawals from Coverdell education savings accounts are free from federal income taxes as long as the withdrawals are used to pay qualified education expenses.

529 savings plans

These plans offer a more substantial amount of flexibility since the new tax laws have gone into effect. Just like a Coverdell account, qualified withdrawals from state-sponsored 529 plans are now federal-income-tax-free, and withdrawals from 529 plans sponsored by private institutions will, beginning in 2004, also be free from federal income taxes.

Section 529 plans now also allow one tax-free transfer within a 12-month period from one qualified tuition program to another for the benefit of the same designated beneficiary. Anyone at any income level can contribute to a 529 plan. Investors can contribute up to $55,000 per beneficiary in a single year without federal gift tax consequences, (for married couples, the contribution amount exempt from gift taxes is $110,000), provided no additional gifts are made to the beneficiary for a five-year period.

The new tax law also now offers the opportunity to make contributions to both a Coverdell education savings account and a 529 plan for the same child in the same year without penalty. It is essential to keep in mind that withdrawals from either a 529 plan or a Coverdell account for non-educational purposes are subject to a 10 percent penalty from the Internal Revenue Service.

Student loan interest deduction

Because not all parents can save 100 percent of a child's educational costs, the new tax laws also have extended the student loan interest deduction. Now you can deduct the full amount of interest paid on student loans, regardless of the time period. Additionally, income limits to be eligible for the deduction have increased.

It is important to talk with your financial consultant about which investment strategies are right for you and your children.

It is best to start with a separate analysis of how much you will need to save for each of your children before establishing separate accounts for each.

Because the tax law changes mentioned above are set to expire at the end of 2010 unless they are extended by legislation, now is the perfect time to take advantage of the new tax laws for education savings.

Regardless of how you choose to save for your children's education, starting as soon as possible can help you get an A+ in Education Savings 101.

(The preceding article was provided by Timothy M. Reese, vice president of investments with A.G. Edwards & Sons, member SIPC.)