Q: My son is just a month old, and I want to start saving for his college. What do I need to know about an Education Savings Account?
A: It used to be that you could sock away only $500 a year into an Education IRA to cover college costs for any child under age 18. Now the rules have changed — and for the better.
Beginning in 2002, Education IRAs became Coverdell Education Savings Accounts (or Education Savings Accounts, for short). Using these new vehicles, you can contribute as much as $2,000 annually, and the money grows tax free. As always, any money that hasn't been used or transferred to a sibling by the time the child reaches 30 must be withdrawn. It's taxed as income, and the child is assessed a 10 percent penalty.
- Improvements: These accounts—unlike an Education IRA—can be used for kindergarten, primary- school and secondary school tuition and expense, as well as higher education costs. You can also use the money for school uniforms, books, and room and board. In some instances, a new computer may make the grade.
- How it adds up: With an Education IRA, it was tough to make much of a dent in college costs. Assuming you saved $500 a year from now until your son was 18, and the money earned 9 percent annually, the account would be worth just $23,000 by the time your kid started college. Now if you max out your contributions—meaning you put $2,000 away every year—you would have $92,000.
Jean Chatzky’s Bottom Line
This week: Don’t throw away these tax documents
All too often, people lose hundreds—if not thousands—of dollars in potential deductions because they haven't put their financial paperwork in order in the prior months. You don't have to save every piece of paper. For example, credit card and bank statements can be tossed after three years. But when the document records the amount you invested—whether in a mutual fund or a new bathroom in your house—you'll want to keep it until you unload the original investment. Why?
- The reason. If you don't keep tabs on your cost basis (the amount you originally spent on the investment), you could be cheating yourself when computing the capital gains tax you owe when you sell.
- The method. Use a financial software package to help you keep track of the cost basis for your investments, charitable contributions, business expenses, and the like. Or you can do it the fifth grade way: Store things by category in a three-ring binder.
Jean Chatzky is the financial editor for “Today,” editor-at-large at Money magazine and the author of “Talking Money: Everything You Need to Know About Your Finances and Your Future.” Copyright © 2004. For more information, go to her Web site, www.JeanChatzky.com.
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