Choosing the Option That's Right for You

Each family's situation is different, but here are some guidelines that may help you decide which investment options make the most sense for you. Your tax advisor can help you make the final decision.

Maximize Tax Advantages

For most families, the tax-free growth potential of an Education Savings Account is hard to beat. Although investing in an Education Savings Account may limit your participation in other federal financial-aid programs, you can work around these restrictions to maximize your benefits.

Don't Forget about the Hope and Lifetime Tax Credits

The Hope Scholarship Credit provides a 100% tax credit for your first $1,000 in out-of-pocket tuition and fees (not room and board), and 50% on the next $1,000. The credit only applies to the first two years of college, and the student must be enrolled at least half-time at a post-secondary program that leads to a degree, certificate, or other educational credentials.

As for the Lifetime Credit, a taxpayer may claim 20% of the first $10,000 of out-of-pocket tuition and related expenses. There is no limit on the number of years it can be used for tuition and expenses incurred, and it is family-based (meaning there is only one credit per family regardless of how many individuals are in college). A student only has to be enrolled in one course (in any undergraduate, graduate or job improvement program) to be eligible for the Lifetime Credit. The Lifetime Credit cannot be used along with the Hope Credit.

Both tax credits are limited to adjusted gross incomes (AGI) of $50,000 for those filing single and $100,000 for those married filing jointly. The amount of the credit is gradually reduced for single individuals with AGI between $40,000-$50,000 and married couples filing jointly with AGI between $80,000-$100,000.

Consider Your Income

Some families don't qualify for much financial aid because their incomes or other financial resources are too great. Those families may wish to consider options such as UGMAs, UTMAs or Education Savings Accounts which provide important tax benefits. Their impact on financial-aid eligibility isn't meaningful if your family is unlikely to qualify. If you think you will qualify for tuition assistance, however, consider keeping most of your educational investments in your name, not your child's.

Know Your Child

One key difference in the various college planning options is the amount of control over the money they give to your child. If you're concerned that your child may use college investments for a car rather than a cap and gown, investing in your own name may be a smarter move. If, however, you're confident that your child understands the importance of using educational investments only for school, you may want to give them more control over the assets – and take advantage of the tax breaks provided by those options.

Baby or Teen?

If your child is only a few years from college, you probably have a good handle on your projected college costs as well as your financial aid picture. If your child is just an infant, however, both may be more of a mystery. Government programs and financial-aid calculations change over time – so if your child is still in diapers, keep tabs on how the rules change over time. They may lead you to alter your college planning strategies.

Something Is Better than Nothing

Most parents can't afford to invest enough to cover the full cost of a child's college education, especially while they're preparing for their own retirement and coping with other family expenses. But even a few dollars each month can help, especially if you start early.

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