Use Savings Bonds to Supplement College Fund
My son is two years old, and I am buying a $200 savings bond every month for his college expenses. Am I doing the right thing or should I switch to another investment option?
I'd recommend putting the bulk of your son's college savings into a different investment, but keeping a portion in savings bonds is a fine idea.
Because your son has 16 years before college, you can afford to take more risk in pursuit of a higher return. That would probably mean investing in stocks or stock mutual funds.
And you could get the bonus of tax-free earnings if you invest through a Coverdell education savings account or a state 529 plan.
Coverdells are great if you prefer to manage your own investments because you can open an account wherever you choose. Another perk: You can use the proceeds not only for college costs but also for private elementary or high school and even for expenses such as camp or a computer.
And because you are saving in relatively small monthly increments, the $2,000 annual contribution limit on Coverdells wouldn't be a drawback.
If you'd rather have someone else manage your investments, look to a 529 plan. You'll pay higher fees than with a Coverdell, but you can put your savings on autopilot in an age-based portfolio that becomes more conservative as your son gets older and college bills loom.
In the case of both Coverdells and 529 plans, your earnings will be tax-free if you use the money for qualified education expenses. But for 529s there's a booby trap: Their tax-free status is set to expire after 2010, unless Congress renews it -- which is expected but not guaranteed.
Even though stocks are a more suitable investment based on your son's age, keeping a portion of your college kitty in savings bonds balances your risk. Traditional EE bonds pay a relatively low rate of interest -- currently 3.2% --but they're safe and easy to purchase. And you know exactly how much you'll have when the bonds mature.
Play your bonds right, and the earnings can be tax-free if used to pay for college expenses. To get the tax break, the bonds must be held in your name, not your son's.
And you should expect to meet income requirements. In 2006, for example, interest escapes taxes for couples who earn less than $124,700 on a joint return, or single filers earning less than $78,000.