Save Early, Often -- And Wisely -- For College

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It's that time of year when college students reach for their backpacks and head back to campus -- while their parents reach for their checkbooks and head for the Tylenol.

If your children or grandchildren are still quite young, though, you can take steps now to reduce the headaches that may come from those big college bills.

Just how expensive is it to send a child through college these days? It's pretty expensive. In fact, it costs more than $16,000 for one year at a four-year public college or university, according to the College Board. And, college costs have been rising considerably faster than the general rate of inflation, so the high costs of higher education are, in all likelihood, only going to rise further.

Of course, you may not have to foot your child's college bills all by yourself. Scholarships and loans are available, and many students work part-time jobs, both during school and on summer vacations. Yet, you may need, or want, to help pay for a sizable percentage of college expenses. To meet this obligation, you need to save early, save often -- and use the right savings vehicles.

Savings options

Fortunately, you've got some attractive options. Here are some of the most popular:

• Coverdell Education Savings Account

Depending on your income level, you can contribute up to $2,000 annually to a Coverdell Education Savings Account (ESA). Your Coverdell earnings and withdrawals will be tax-free, provided you use the money for qualified education expenses. (Any non-education withdrawals from a Coverdell ESA may be subject to a 10 percent penalty.) You can place your contributions to a Coverdell ESA into virtually any investment you choose -- stocks, bonds, certificates of deposit, etc.

  • Section 529 savings plan

In a Section 529 savings plan, you put money in specific investments, managed by an investment professional. Contribution limits are quite high -- more than $200,000 per beneficiary in many state plans, although special gifting provisions may apply. Contributions are tax-deductible in certain states for residents who participate in their own state's 529 plan.

All withdrawals will be free from federal income taxes, as long as the money is used for a qualified college or graduate school expense of your child or grandchild. This tax benefit was scheduled to expire in 2010, but it was made permanent by one of the provisions in the Pension Protection Act of 2006. (Withdrawals for expenses other than qualified education expenditures may be subject to federal, state and penalty taxes. Also, Section 529 distributions will appear as income on the child's tax return, which could affect financial aid calculations.)

  • Permanent insurance

If you own some type of "permanent" insurance policy, such as whole life or universal life, you'll have a chance to build cash value.

Your earnings can grow on a tax-deferred basis, and you can take policy loans for virtually any reason you choose -- including paying for college. Keep in mind, though, that if you don't fully repay the loan, your policy may lapse, and if you pass away before repaying the loan, the total amount owed, including interest, will be subtracted from the death benefit.

Before making any of these moves, please consult with your tax and financial advisers. But don't wait too long: Your children may be young now, but tempus fugit -- time flies.

Scott Flake is a licensed financial adviser with the firm of Edward Jones. He hosts a weekly informal investment discussion on Tuesdays at 10:00 a.m. at his office at 411 S. Beeline Highway, Suite B. For more information, call him at 928 468-1470.

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