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Chapter 8. Using a 401(k) to Achieve You... > Education Funding - Pg. 85

Using a 401(k) to Achieve Your Other Financial Goals 85 Education savings accounts work like a Roth IRA. In other words, you contribute after-tax dollars to your account, and the earnings on your investments grow tax-free. The best news is that, when the money is used for "qualified higher education expenses," distributions from your account are tax- free. From 1998 to 2001, annual contributions to any one account were limited to $500, and only families with adjusted gross incomes below $150,000 and singles earning $95,000 and under could fully participate. For 2002 and beyond, annual contribution limits will be $2,000. And more can participate: For fam- ilies, the AGI must be below $220,000; for singles, the AGI must be below $110,000 to fully partic- ipate. Other good news for 2002 includes being able to use these monies for kindergarten through graduate school, including both public and private schools. If so inclined, your employer, school, church, or synagogue can also contribute to your account. Our Advice If you want to save more than the $2,000 per year limit, just open an account in each of your children's names. Opening multiple accounts lets you keep it "all in the family," so that if the first child doesn't go to college or can't use all his account, you can transfer the remaining monies to the second child ... and so on and so on. Two types of qualified state tuition plans (QSTPs) exist--prepaid tuition plans and higher education savings account plans (a.k.a. Section 529 plans). We recommend that you look into Section 529 plans because they are very flexible. Some 43 states sponsor them, and some, such as Missouri and New York, give you a state income tax deduction. As with education savings accounts, distri- butions are tax-free. A minor difference between the two is that 529s can be used only for college and graduate school expenses. The nice thing about 529s is that parents (or anyone else, for that matter) can contribute up to $10,000 per year to a child's account, and neither contributors nor beneficiaries must meet any income limits. The only limit is that contributions to any one account cannot exceed approximately $235,000. With both plans, your investment grows tax-deferred; when monies are used for college or graduate school expenses, the built-up earnings in your account are distributed tax-free! Terms to Know Education Savings Accounts and Section 529 plans can be used to pay qualified education expenses. The IRS defines these expenses as tuition, room, board, lab and other required fees, books, supplies, equipment, and special needs services. Payments made by children to their parents for room and board may also qualify. And because education savings accounts can be used for elementary and post-secondary schooling, expenses such as academic tutoring, computer equipment, Internet access fees, uniforms, transportation, and extended day programs will also qualify.