Saving for College on Shine

<img alt="" src="http://img.timeinc.net/realsimple/i/p/rstv/rstv_save_college.jpg" align="left" width="180" height="240">Don't panic -- you have options If they gave out scholarships just for being wonderful, no doubt your child would have all the money she needs for college. But, in reality, the competition for scholarships (merit-based and need-based money you don't have to pay back) and grants (need-based money you don't have to pay back) is fierce, so you're better off not relying on them as a source of income. "Not unless your kid is in the sixth grade and is seven feet already and can dunk the basketball -- or plays Carnegie Hall," says Joseph Hurley, founder of the financial-information website Savingforcollege.com. While you might consider using retirement funds for your children's education, think carefully about that before forgoing plans geared specifically for college. As Hurley explains in his book, Savingforcollege.com's Family Guide to College Savings (Savingforcollege.com, $8, www.amazon.com), you cannot easily borrow from your 401(k), and you might have to pay income tax on money you take out of an IRA prematurely. So shoulder the burden of college bills by putting money in one (or several) of the following three most popular plans. See Real Simple's <a rel="nofollow" href="http://www.realsimple.com/realsimple/package/0,21861,1697911-1591814,00.html?xid=yshisavco2">23 Surprising Things You Can Get for Free</a>. 529 Plans Named after the Internal Revenue Code Section 529, 529s are state-run, tax-advantaged college savings accounts. At least one -- or, in most cases, two -- are operated by every state. They come in two varieties: a prepaid tuition plan and a savings plan — both tax-free when you withdraw the money for college. Neither 529 plan limits how much you can contribute annually, although they both have an overall limit, which can be as much as $300,000 per beneficiary. And the money is tax-free when you use it for education (but be warned: Tax laws can change). Keep in mind that if you don't use the money for college, there are penalties. "If you think there is a decent chance this money is not going to be used for college, then a 529 is probably not the vehicle for you," says Kathy Kristof, author of Taming the Tuition Tiger: Getting the Money to Graduate With 529 Plans, Scholarships, Financial Aid and More. (Bloomberg Press, $19, www.amazon.com). And each state (or the broker hired by the state to manage the plan) charges fees for opening and maintaining an account, as well as for many other investment activities. Sometimes those fees make the effort less worth your while. Both Kristof and Hurley recommend that when you start shopping for a 529 (compare them all at Savingforcollege.com), you start by looking at your own state's plans. You're not required to enroll in your local option, and sometimes it's not the best one out there. Investment options, fees, restrictions, and plan performance all vary, so do a little comparison shopping (in and out of state) before signing up. Learn How to <a rel="nofollow" href="http://www.realsimple.com/realsimple/package/0,21861,1697911-1019566,00.html?xid=yshisavco3">Save Money All Year Long</a> at Real Simple. Here, the lowdown on the two 529 plans. With prepaid tuition plans, you are doing just what the name implies: paying a percentage of future tuition by putting money in the account now. Pros: "You're locked in at a steady tuition rate," Hurley says, "so future tuition increases don't affect you, because you've already paid for it." Since college tuition has been increasing about 6 percent each year, you could wind up with a good deal. Con: The institutions at which you can use this tuition credit are limited -- usually to major public universities in your state. You might be able to transfer the value of the plan to use in a private or out-of-state school, but, depending on the state, it won't be worth as much. A college savings plan is "like a retirement account," Hurley explains. You deposit as much as you can each year and invest the whole account in, say, a mutual fund or a stock fund -- kind of like a 401(k). Pros: The money is yours tax-free as long as you use it for college expenses, and you can use it at any accredited school you choose. You also have some freedom when it comes to how to invest it (within the limits of what's offered by the plan you choose). Cons: As with any investment fund, you take a bit of a gamble when you choose how to invest it. If the market doesn't do well, neither do you, and you might not end up with enough to pay for tuition. "You make contributions as you're able and select from the investment options available to you," says Hurley, "and hopefully it grows over time." Coverdell Education Savings Account Coverdells basically work like an IRA: You contribute to them annually, and you can choose how you invest the money. Pros: Unlike 529s, you aren't limited to using the dough for college. "I recommend Coverdells to people who think they're going to send their kids to pricey private high schools," says author Kathy Kristof, explaining that Coverdell money can be used toward kindergarten through grade 12, as well as college and graduate programs. Cons: You can't contribute after your child turns 18, and the money must be used (and used only for education funds) before he or she turns 30. What's more, there are annual limits on the total amount you can contribute to each beneficiary ($2,000), and if your income is above a certain number (above $110,000 for a single individual, above $220,000 for a couple filing jointly), you cannot open this type of account at all. See <a rel="nofollow" href="http://www.realsimple.com/realsimple/package/0,21861,1697911-1603915,00.html?xid=yshisavco1">Money-Saving Secrets of the Pros</a> at Real Simple. Uniform Gift to Minors Act The Uniform Gift to Minors Act is just that -- an unqualified gift to your child, who gets total control of the money when he or she turns 18. "This used to be the number one way to save for college," says Kristof, "but it's fallen out of favor." Pro and Con: The money belongs entirely to the child. That's because once you put savings into an UGMA and the child reaches a certain age, the cash belongs to him, and he can spend it on anything he likes. "If you think your kid is irresponsible, that's a huge detriment," Kristof cautions. "But if your kid is responsible, the UGMA can be a huge advantage, because you have more flexibility with that account than you have with a 529 or a Coverdell." Maybe your daughter is a natural-born entrepreneur who wants to start her own business before going to college, or your son wants to travel the world before settling down to study international affairs. Either way, with an UGMA, your children have that option. The question you have to ask yourself is, Do I want them to have that option? "You have to make guesses about a lot of things that you don't know," says Kristof, "like what your kids are going to be like when they're older. But what you do know is how you're going to feel about it." If a college education is the most important thing to you, she says, save your money in something other than an UGMA. Gift Tax Annual Exclusion This isn't so much a savings plan as a loophole to take advantage of in any savings plan. Basically, if you come into a big chunk of money and want to put it all into one of your college accounts, as long as you stay under $11,000, you won't have to worry about taxes on it. "The relevance is that when you make contributions to a 529 plan or to a Coverdell, even though it's your account, it's still considered a gift from you to the beneficiary," Joseph Hurley, founder of the financial-information website Savingforcollege.com, says. "If you're making large contributions, you have to be concerned about gift taxes, so many people try to stay under the $11,000 annual exclusion." To learn more about all these savings options, go to www.savingforcollege.com, www.smartmoney.com, www.finaid.org, or www.irs.gov. More from Real Simple: <a rel="nofollow" href="http://www.realsimple.com/realsimple/package/0,21861,1697911-1577271,00.html?xid=yshisavco4">Spend Money to Save Money</a> <a rel="nofollow" href="http://www.realsimple.com/realsimple/package/0,21861,1697911-1206325,00.html?xid=yshisavco5">Cut Your Energy Costs</a> <a rel="nofollow" href="http://www.realsimple.com/realsimple/package/0,21861,1697911-1684343,00.html?xid=yshisavco6">Credit Cards 101</a>