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Author: DrDraconian One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 75383  
Subject: Re: Retirement investing Date: 11/4/2008 7:54 PM
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We are just about to start a college fund for our infant. Besides my IRA contribution, that seems to be the only option left to defer taxes. I was just looking at the 1040 form to see where the college fund contribution gets reported and deducted; but did not find it. I wonder how that works.

It doesn't work the way you think. There is no up-front deduction for college savings plans. There are potential deductions and credits for actual, current college expenses (will depend on income levels and many other factors), but no deductions for savings that are specifically directed towards saving for college.

The two plans currently existing that were specifically developed for college savings are the Coverdell Education Savings Account (formerly known as the Education IRA), and state-sponsored 529 Plans. Both of these allow you to put away after-tax money (i.e. there is no federal income tax deduction), but the earnings/growth in the account will accumulate tax free, and will not be taxed upon withdrawal if it is used to pay for certain, allowed education-related expenses (there will be tax due, plus penalties, if the money is withdrawn and not used to pay for educational expenses). The one caveat to the after-tax nature of these two plans is that many (most/all?) states that have income taxes will allow you deduct contributions to a 529 plan IF you contribute to their particular 529 plan (i.e. if you live and pay taxes in CA, you will get a CA state income tax deduction if you contribute to a CA 529 plan, but not if you contribute to, say, a VA 529 plan. Why would you even think of using another state's plan, you ask? Because the different plans have different rules/investment options, and some plans are more investor friendly than others).

The Coverdell ESA currently has contribution limits of $2K/ year, while 529 plans have much higher limits. You can use both savings plans if you like, but when it comes time to withdraw money when your child is in college, you need to be careful about how you allocate the expenses (you can't double dip, i.e. withdraw money from both sources to pay for the same expenses).

The details, especially for 529 plans, are way too complicated to try to cover in a single post. Just Google "Coverdell ESA" and "529 savings plan", and you'll be well on your way to information overload. Luckily, since your child is an infant, you have some time to learn about these things (of course you don't want to procrastinate too long - i.e. years, because time is money :)

Of course, with a change in administration, government priorities will possible change, and these tax-advantaged plans may be changed / eliminated / replaced with something else. You'll have to stay updated on what goes on as your child grows.

Don't forget, you can (and should) save for your child's educational expenses in non tax advantages accounts as well, which will typically not have as many limitations on how you accumulate or spend the money. Diversity in investments is a good thing.

DrD
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