Ways to Save for College

Congress has recently made changes to several of the “kiddie tax” laws. Parents of high school seniors and current college students should seriously consider selling some or all of the child’s assets before the end of the year.

Kiddie tax is imposed on any child under 18 years of age. Before ‘06, the law only affected children under 14. Currently, the first $850 of a child’s investment income is tax free. The next $850 is taxed at their tax rate (probably 5%). Any excess over $1700 is taxed at the parent’s tax rate (15% capital gains rate).

Next year, this law is going to be expanded to include dependent full-time students under 24 years of age! Now is a great time for any 18-23 year old students to cash out some or all of their investment income, especially any short term investments held under one year.

To max out your benefits, you may give your child up to $12,000 per parent this year without the gift tax kicking in. This would translate into a $1200 tax savings over waiting until January 1st, 2008 to do so. These changes also make 529 plans more attractive than ever because of their tax free nature if used for educational expenses.

Changes to the Coverdell ESA in 2011 could result in the death of the plan. Unless Congress steps in, the Coverdell will no longer be eligible to fund elementary and high school tuition. In addition, when using the Coverdell to pay for college, you may not be able to take advantage of valuable tax credits.

Last year, Congress passed a bill that allows for the use of tax credits with 529 plans but did not include the Coverdell in the bill. Coverdells seem to be ignored because of their low contribution limits (currently $2,000 per year) but hopefully Congress will take notice of the importance of private primary education funding and do something to preserve this very useful savings account.

Most people with 529 plans will opt to invest in mutual funds, not because this is their only option but because it is the easy option. However, with a little research, you will find there are a plethora of other investment options available for your 529 plan. These options include:

• Equity indexed investments
• Guaranteed investment contracts
• Fixed income pools managed by the state
• Certificates of deposit

529 plans are limited to switching investment options once per year or with a beneficiary change, so you will want to choose your investment options carefully but do take a look at all available options before making your decision.