A Newborn Saving for College

Our son is five weeks old, so it's time to start thinking about saving for college. Oh my!

Actually, we have had his Social Security number for a couple weeks now. We could have done this paperwork at half his current age.

There are two kinds of Educational Savings Accounts (ESAs), the 529 ESA and the Coverdell ESA. Both work like a Roth IRA in that contributions not tax-deductible but withdrawls are tax-free if done as intended.

Most of the time the Coverdell ESA is the wrong choice. It is specific to a single person less than 30 years old, has an annual contribution maximum is $2,000, and has a 10% extra fee (tax) for money beyond what is needed for education, due at the latest at age 30. So you have to be very careful not to put too much money into it.

The advantages of a Coverdell ESA is that its money can be used for high school expenses, and it has more investment options. So if you knew your child was going to a private high school a small Coverdell ESA would make sense.

But in general the 529 ESA is the better option. It has very high allowance to how much can be deposited, and a lot of flexibility with changing its "beneficiary" among family members. Thus you are really building a permanent legacy of college finances that your children and grandchildren can share throughout the generations.

The 529 ESA is only for college expenses. It has a fair number of options for what investments can fit into it: most popular are funds that automatically become more risk-averse as the child approaches college age.

Both types of ESA are quick to set up (the usual couple weeks for papers to travel to and from us through the mail) and require the child to be born and have a social security number.

For Oregon residents the 529 ESA is an even nicer option. Oregon is one of the few states that offers a state annual income tax deduction for 529 ESA contributions, but only if the 529 ESA is one of the official three flavors with which the state works. Two of these three can be part of a family's established investment account, for ease of bookkeeping.

UPDATE: Fidelity has a page describing 529 ESAs. Among other things, it links to a page by Archimedes allowing a quick side-by-side comparison of 529 ESA options by state.