Funding an education? Some US Savings Bonds alternatives

Q: I purchase a $100 savings bond for each of my grandchildren on their birthday. It has become a tradition, but with recent changes I read about, it doesn't seem to be a very good investment anymore. Is there anything similar I could purchase that would benefit them more?
L.D., via e-mail

A: If the money is meant for higher education expenses someday, Nate Wenner, a certified financial planner in St. Paul, Minn., recommends either a 529 College Savings Plan or a Coverdell Education Savings Account (ESA, formerly called the Education IRA). Either of these would provide the tax benefits of savings bonds, with the possibility of higher returns. (A 529 plan, for instance, typically invests in conservative mutual funds.)

Inside such an account, an investor can generally choose from several investment options or choose a predefined, age-based, well-diversified investment strategy. Earnings on these accounts can be distributed tax-free when used for qualified education expenses. Unlike savings bonds, however, there is some risk that you may not get back all that you put in because your dollars are being put to work in the stock market, Mr. Wenner notes.

Brokerages manage and offer ESAs. Individual state governments sponsor 529 plans.

Q: I am currently in medical school and not working. I used to work for the University of Minnesota and now have about $1,225 in the state-run retirement plan. This small amount doesn't qualify for annuity, and I don't intend to put any more money into that plan. It would be nice to have that money now, but I would have to pay 20 percent federal withholding and possibly a 10 percent tax. I'm wondering if it would be OK to take that money out. Since I have no income, would I get those taxes back?
S.E., via e-mail

A: Mr. Wenner says that it may very well be a good time to take a distribution.

True, it will be treated as "taxable" income, he says. But if you are in low tax bracket, and you don't have much income (or no income, if it's less than your exemptions and deductions), then you may likely get back all the withholding at the time of your tax return, Wenner says.

Q: I am one of seven brothers and sisters who own a house which may be sold this year. Two of the relatives have lived in the home for 50 to 70 years. Others live elsewhere. How do taxes apply to the sale?
D.C., Beverly, Mass.

A: For those relatives who were not also using the home as a primary residence for two of the preceding five years, the sale of the home would generate a taxable capital gain, says Vince Clanton, a certified financial planner in Atlanta. Mr. Clanton refers you to IRS Publication IR-2002-142, which states "for joint owners who are not married, up to $250,000 of gain is tax-free for each qualifying owner."

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