While using dedicated college saving tools like 529 Savings Plan, 529 Prepaid Tuition Plan and Coverdell ESA for college saving purpose usually makes the most sense, you might also want to consider some other options. Why? One reason is sometimes you are not sure your kid will attend college. Another reason is you kid might be doing exceptionally well so that he is eligible for some merit-based scholarship. In these scenarios, you might not want to restrict yourself to the various rules in 529 Plans and Coverdell ESA that will pose penalties on withdrawals for non-educational purposes. Even if you don't fit into these categories, you might still want to balance between retirement savings and college savings.
So, take a look at how some other tools can fit into your college savings picture:
You can contribute $4,000 a year to your Roth IRA account, which will allow tax-free growth of your contribution for retirement purposes. At the same time, you can withdraw your original contribute any time without penalty. Early withdrawal of the capital appreciation part is usually subject to 10% penalty, but there is a specific rule for college expenses that can waive the 10% penalty (you still need to pay tax on the appreciation part for college expenses). Plus, your Roth IRA balance is shield from financial aid calculation.
If you only have limited money to put aside every month, you should consider to contribute to 401(k) first to get the maximum employer match, before considering other options. It is correct that most 401(k) does not allow you to withdraw for your kids' college expenses, but if you don't have other resources to pay for your kid's college, most 401(k) plans offer 401(k) loan to your rescue. Plus, your 401(k) balance is hidden from financial aid calculation, which helps your overall status.
Saving Bonds in After-Tax Accounts
Thanks to Treasury Department's Education Bond Program, saving bonds can help delivering tax-free growth when you redeem the bonds for "qualified higher education expenses at an eligible institution or State tuition plan." Note some restrictions and a relatively low income threshold applies.
By now, we are pretty much done with the fact finding part. In the final installment of this series, I will piece the information together and draw my roadmap.
(This article is a component of the 10-part "Saving for College" series at PFBlog. If you want to read from the start, follow the links at this Table of Contents page.)