Compare college savings plans

Question: Help! I have two kids, ages 5 and 7, and want to start a college fund for them. What would be most beneficial? An education savings account, a 529 plan or a Roth IRA? Please define all the above.

Answer: Lately I've received a flurry of queries regarding 529s and other college savings plans. I'll try to address most of them over the next few weeks, starting with the basics.

When push comes to shove, you can't really go wrong with any of the college savings vehicles mentioned above. But each has pros and cons.

Let's start with the Coverdell Education Savings Account. The Coverdell is often overlooked because of its biggest con: You can only contribute up to $2,000 a year per child. But that shouldn't be a deterrent for families with young children who plan to save for college a little at a time. And the Coverdell has a lot of pluses.

For one thing, you can use the proceeds not only for college expenses, but also to pay for a private elementary or high school or for other educational expenses, such as camp or a computer.

For another, you control where you invest the money. For children who are 5 and 7 years old, with 10 years or more before college, investing in stocks or stock mutual funds would certainly be appropriate. Because you'd be investing on your own, you wouldn't have to pay extra layers of management expenses (as you would with a 529 plan) that would eat into your returns.

Also, the earnings from a Coverdell account are tax-free when used for education expenses — and there's no trap in the law that can overturn that, as there is with 529 plans.

The tax-free status of 529s currently expires after 2010 — so they're not good for young children. Congress is expected to eventually make the tax-free withdrawals permanent, but it hasn't yet.

You're smart to put Roth IRAs in the same college savings category as Coverdell accounts. Even though the primary purpose of a Roth is retirement, it can do double duty for college and help make up for the limitations of a Coverdell.

With a Roth, you can withdraw your contributions at any time, tax- and penalty-free. So if you want to save more than $2,000 a year, you can use a Roth to supplement a Coverdell or let the money ride for retirement.

Next: Pros and cons of 529 college savings plans.

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Have a question about kids and finances for Dr. Tightwad? Write to Dr. T at 1729 H St., N.W., Washington, D.C. 20006. Or send the good doctor an e-mail message (and any other questions for this column) to jbodnar@kiplinger.com.