529 Savings Plans

College savings plans created by states are popular because account earnings grow free of federal (and possibly state) income tax and withdrawals for qualified expenses are not taxed. Another advantage is that parents retain control over these accounts. If your child never uses the money, you can name a new account beneficiary — a sibling, for example. However, money that isn’t used for qualified higher education expenses — such as tuition, books, room, and board — will be subject to taxes and possible penalties. Another potential disadvantage is that many plans have limited investment choices.

Coverdell Education Savings Accounts

Formerly known as Education IRAs, Coverdell ESAs also provide tax-free earnings and withdrawals for qualified education expenses. Unlike a 529 plan, an ESA can be used for elementary and secondary school expenses, as well as for college. These accounts offer investment flexibility — you generally can invest in any stock, bond, or mutual fund you choose. A disadvantage of Coverdell ESAs is the limit on contributions. The most that may be contributed each year is $2,000 per child, subject to an income-based phaseout. (The $2,000 contribution limit is phased out for married-joint filers with adjusted gross income between $190,000 and $220,000 and for single individuals with income between $95,000 and $110,000.) And, as with 529 savings plans, money that isn’t used for qualified expenses will be subject to taxes and possible penalties.

Trusts

Trusts established for the benefit of a minor are popular with grandparents who want to help with college expenses and potentially save estate taxes. One advantage is that the trustee has control over investments and distribution of the assets (in accordance with the trust’s terms). If desired, the trust can be structured to take advantage of the $12,000 gift-tax annual exclusion ($24,000 for joint gifts by a married couple). Earnings are taxed, though generally to the trust or beneficiary instead of the donor. Planning can minimize the tax effects.

Custodial Accounts

As with a trust, there are no income limits to worry about with a custodial account set up for a child. And married couples can contribute up to $24,000 per child, per year, gift-tax free. Custodial account earnings are taxed to the child. If he or she is under age 14, income above $1,700 (in 2006) is taxed at the parent’s rate due to the tax law’s “kiddie tax” rules. The biggest disadvantage of a custodial account is that the child assumes control of the account at age 18 (21 in some states) and at that point can use the assets for any purpose he or she wishes.

Which option is right for your family? The answer depends on your unique financial situation and your child’s age. In fact, you aren’t limited to only one and may decide to invest in a variety of ways to meet your goals.

The information above is provided as a service by Security Mutual Life Insurance Company of New York. These programs can be valuable tools when planning for your child’s or grandchild’s future educational endeavors. You may even wish to consider cash value life insurance as a college funding option.

However, before making any financial decisions, it is best to consult with a qualified advisor or advisors specializing in the field in question. Our Security Mutual Representatives, working in conjunction with your other professional advisors, can be instrumental in helping you plan for the best financial future for your family. Please contact us if you have any questions or are in need of planning assistance. (Legal Notice)

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