By JLP | June 20, 2008
I’ve mentioned over at Chief Family Officer that I plan to send my children to private school. One of the difficulties I run into when it comes to saving for college is that I don’t necessarily want to tie my money up for 18 years in a 529 plan when there’s a possibility, however slim, that we just might need it to pay for private school tuition.
While a 529 plan has many advantages, I hate the idea of paying a penalty if I need to withdraw the money before my kids start college. So I’ve been looking for alternatives to 529s, and here’s what I’ve come up with:
- Coverdell ESA – This is the obvious alternative, and my favorite. The investment options within a Coverdell are akin to those in an IRA, and the funds can be withdrawn to pay for education-related funds starting in kindergarten. (Note: Even if your children attend public school, you may want to consider a Coverdell because funds can be used to pay for tutoring or even extended day programs.) Coverdell contributions are post-tax and growth is tax-free, like in a Roth IRA. The real downside is that contributions are limited to $2,000 per year. There is also an income limit for contributors. And unfortunately, the provision allowing funds to be used for grades K-12 expenses expires in 2010 unless Congress extends it.
- Roth IRA – Contributions can be withdrawn at any time without penalty, so long as the account has been held for at least five years. Additionally, one of the exceptions to the early withdrawal penalty is college-related expenses. This means that if I needed the money before my kids enter college, I could withdraw the contributions I’ve made without penalty. And when they entered college, I could withdraw all of the funds. This assumes, of course, that I have adequate retirement savings in other accounts. The contribution limit is low compared to the limit for a 529 plan but I can’t save the maximum Coverdell and Roth IRA contributions while also paying for private school and saving for retirement anyway.
- U.S. Savings Bonds – Under the Education Savings Bond Program, you don’t have to pay income tax on savings bonds used to pay for college expenses. There are income limitations and restrictions on which bonds qualify. Bonds must be held for five years or a penalty will be imposed upon redemption. The annual purchase limit for savings bonds has been reduced to $5,000. And the rate of return is low, especially considering how long the bonds will ideally be held (although your money will be extremely safe).
Obviously, your options are limited if you want to save for college in tax-advantaged accounts while avoiding having to pay a penalty if you withdraw your money early. But with the Coverdell and Roth options, you can save a decent amount each year that will still be accessible should you need it.
Have I left out any options?