College savings options as outlined in the WSJ

Where to Save

Wary of market volatility and in search of more flexibility, more families and advisers are expanding their college-savings repertoire. Here are some options to consider:

529 Savings Plans 

Qualified distributions are taxfree, and many states offer tax deductions or credits for contributions.

• Pros: Can result in big tax savings for families able to sock away substantial sums.
• Cons: Some plans may have limited investment choices and charge high fees, and savers can face taxes and penalties if the funds are pulled out for other purposes.
• Financial-Aid Impact: Minimal, if treated as parental asset.

529 Prepaid Plans

Families make an upfront payment in exchange for future tuition contracts or credits.

• Pros: Prepaid plans aim to cover tuition no matter how much it increases.
• Cons: Some states, facing budget woes and rising tuition, have had to close their plans to new participants, raise prices or impose fees.
• Financial-Aid Impact: Minimal, if treated as parental asset.

Coverdell Education Savings Accounts 

Offer tax-free growth for education expenses.

• Pros: Cover a broad range of expenses, including college and K-12 expenses, while offering more investment choices.
• Cons: Impose income restrictions and a low $2,000 contribution limit. Current tax benefits extended only for two years.
• Financial-Aid Impact: Minimal, if treated as parental asset.

UGMA and UTMA Custodial Accounts

Accounts in which the parent acts as trustee. Offer some tax benefits where the first $950 of investment income is tax-free. Any income between $950 and $1,900 is taxed at the child's rate, and income above $1,900 is taxed at the parents' rate.

• Pros: Can be used for most anything as long as the proceeds benefit the child.
• Cons: Students gain control of the accounts when they come of age.
• Financial-Aid Impact: Since the accounts are in the child's name, they are counted more heavily in financial-aid formulas.

Taxable Brokerage Accounts

Families can save for college in a standard taxable portfolio.

• Pros: Investors have complete control over their investment decisions; accounts can be used for any purpose.
• Cons: Investors are likely to face a tax bill on growth and withdrawals.
• Financial-Aid Impact: Federal aid formulas count the value of the assets in the account (minus any margin loans) at the time the federal financial aid application is filled out.

Roth IRAs

Investors can generally withdraw their original contributions without taxes or penalties not only for college, but any reason.

• Pros: Offers more flexibility and investment options.
• Cons: If the parent is relying on the account for retirement, any withdrawals will chip away at the nest egg.
• Financial-Aid Impact: Assets aren't counted in aid formulas, although withdrawals of a contribution are treated as income under aid formulas.

Savings Bonds

Interest earned on the Series EE or I bonds is free from taxes if used for qualified higher-education expenses.

• Pros: Among the safest investments.
• Cons: Currently, bonds pay a relatively low rate of return while the tax break is limited.
• Financial-Aid Impact: Income from the bonds is considered income under aid formulas.

Sources: WSJ Research; FinAid.org

 College Saving Gets Trickier - WSJ 1/22/11