I have opened two ESAs, one for my daughter and one for my son. An ESA - Education Savings Account - is an account created as an incentive to help parents and students save for education expenses. (See IRS Pub 2007 -59)

Overview of the account -

The annual contribution limit per beneficiary (student) is $2000.

A beneficiary (student) is someone under the age of 18.

Contributions are not deductible - but deposits grow tax free.

Distributions from the account are tax free, as long as they are used for qualified education expenses - tuition, books, fees, and room and board. (See IRS Topic 310)

Contributions must be made made before the due date of the contributor’s tax return. If you open an ESA for 2007, you will have until April of 2008 to fully-fund the account.

All contributions must be distributed before the beneficiary reaches the age of 30. To avoid taxes the balance of the account can be rolled over into another ESA which has been established for a family member. (See IRS PDF PUB 970)

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My daughter is 8 and and my son is 3, so I have 11 more years to contribute to her account and 16 years to contribute to his account. I like the ESA because I can control the investments inside the account. I can purchase stocks, ETFs, mutual funds, or bonds. (If you are thinking about saving for college, may I suggest that you also look into 529 plans? My buddy Nickel recently wrote and excellent article about the best 529 plans.) I do not like the fact that contributions are limited to $2000. I recently ran the numbers, and if I average an 8% return for the next 11 years, the balance in my daughter’s account would be about $45,000 - probably not enough to pay for tuition and room and board for 4 years of college.

Contributions to an ESA can be used for qualified primary, secondary, and higher education expenses. While I like the ESA, I will also look into funding 529s for my daughter and my son - the low contribution limits bother me a bit.

Let me remind you that I am not a tax professional or financial adviser. Please consult a qualified tax professional before making any tax-related decisions.

How are you saving / planning to save for your children’s college expenses?