Too many investors overlook the impact of taxes. You may be thrilled with how your investment returns look on paper, only to end up writing a huge check to Uncle Sam on April 15^th. You wouldn't want the same thing to happen to your child's college education fund. That's why it pays to consider the benefits of a custodial account under the Uniform Gift to Minors Act (UGMA) or Uniform Transfer to Minors Act (UTMA). Any money you contribute to an UGMA or UTMA is, by law, an irrevocable gift to your child. In other words, the money will belong to your child alone when he or she reaches the age set by state's version of UTMA. You, however, serve as the custodian of the assets in an UGMA or UTMA until your child reaches that age.

What makes an UGMA or UTMA such a worthwhile way to save for college? Under most circumstances, most or all of the income (which includes dividends, interest and realized capital gains) that your child earns in this account will be taxed at a lower marginal tax rate than your own — or not taxed at all. Income tax law provides that children under the age of 14 do not have to pay federal income tax on a significant share of their earned income. Although there are some ceilings on the amount of tax-free earned income a child can make in a year, any additional income is usually taxed at the child's low marginal tax rate.

In addition, each parent and grandparent can contribute up to $11,000 to a child's UGMA or UTMA per year without having to pay a federal gift tax. Consult your tax advisor for more information about how an UGMA or UTMA may fit into your investment plan.

Washington D.C. recently introduced several new tax-advantaged ways to save for college:

Parents and grandparents who qualify under certain adjusted gross income (AGI) ceilings can contribute up to $500 per child per year to a Coverdell IRA. Qualified distributions from these accounts are exempt from federal income taxes. It’s important to note, however, that Coverdell IRAs cannot be utilized in conjunction with most state tuition assistance programs or other tax incentives.

Thanks to certain provisions in the Taxpayer Relief Act of 1997, many states have developed a new tax-advantaged college savings vehicle called a 529 Plan. Although plans differ from state to state, they do share some similar features. Two of the most important are that 529 Plans have no AGI limits and participants can contribute significantly more money to them than to an Education IRA—in some states, you may contribute $100,000 or more to these accounts on an annual basis!  Please check with your tax advisor or at www.collegesavings.org for your state's specific provisions.

The introduction of the Roth IRA for the 1998 tax year, along with recent changes to the rules governing traditional IRAs, have made it easier for parents and grandparents to invest for their child or grandchild's college education. These provisions allow you to withdraw a certain amount of money from your traditional or Roth IRA each year without penalty to finance qualified higher education expenses for you or your immediate family. Taxes may apply in some cases, so you should consult your tax advisor before making any withdrawals.