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Starting a college savings plan for your kids or grandchildren

Deciphering the options

College savings plans come in many varieties, all with different benefits. With so many choices out there, choosing the best for your family can be difficult. Here's how to figure out what's best for your family.

Let's say you have a 12-year-old daughter. What are your options?

Because there are so many choices for college savings plans, this is pretty complicated. Here are a few of the pros and cons, as well as some sources of information for your own comparison.

529 Savings Plans

Each state offers its own 529 Savings Plan, and the details vary. They all, however, provide some common advantages:

  • Money saved in a 529 plan can be used for any college in the United States.
  • The savings are tax-free (both federal and state in Colorado) when used for qualified expenses including tuition, fees, books, supplies, room and board.
  • You can get your money back if your daughter decides not to attend college, but you will owe tax on the earnings and will be assessed a 10 percent penalty.

Potential disadvantages:

  • You'll pay higher expenses than if you had invested the money yourself.
  • The earnings may count as income in financial aid formulas if a grandparent is the donor.

529 Prepaid Tuition Programs

These allow donors to purchase tuition credits for a beneficiary who is expected to attend a public university. The independent prepaid tuition program covers private institutions. (See 52www.independent529plan.com.)

Pluses of prepaid tuition plans include:

  • Tax-exempt benefits if used for qualified expenses
  • State tax breaks

Minuses:

  • This plan may reduce the amount of financial aid awarded.

Uniform Transfer to Minors Act (utma) account

An UTMA is set up on behalf of a minor, to whom income is taxed each year. The child takes control of the money at age of majority (18 or 21). Because the child owns the account, more of this money will be counted toward the family contribution when determining financial aid eligibility.

roth IRA

Money can be withdrawn from individual retirement accounts for qualified higher-education expenses without penalty. If the money has been invested in a Roth IRA for five years, no tax will be due. Withdrawals from IRAs are counted as income in financial aid formulas.

coverdell education savings account

You can contribute up to $2,000 per person each year to a Coverdell account and deduct the contribution from your taxes. These contributions may be used for primary and secondary education expenses. You can make contributions to both a 529 plan and a Coverdell Plan, but there is a potential gift-tax consequence if you contribute a total exceeding $11,000 per person. Accounts can be established with most brokers and mutual fund companies.

additional tax breaks

If your 2004 modified adjusted gross income is less than $53,000 for a single filer or $107,000 for married filing jointly, you can take a few additional tax breaks:

The HOPE Scholarship allows you to deduct 100 percent of the first $1,000 of qualified education expenses and 50 percent of an additional $500 from federal taxes. You can use this credit for two years.

The Lifetime Learning Credit is 20 percent of up to $10,000 of qualified education expenses. There is no limit to the number of years you can claim the credit. You can't apply the same expenses for both the HOPE Scholarship and the Lifetime Learning Credit.

If your modified adjusted gross income is $65,000 or less (single) or $130,000 (married filing jointly), you can deduct up to $4,000 (higher adjusted gross incomes get partial credits). You can't take this tax credit in the same tax year you take a HOPE or Lifetime Learning Credit.

For more information:

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