Find a broker who deals in Education Savings Accounts. These were once called Education IRA's, but were later renamed Coverdell ESA's. Ask the broker all about ESA's and how different they are from other investments in that you buy stocks and mutual funds to accrue money. ESA's are designed for families with incomes slightly above middle class.
Ask your broker about the best stock and mutual fund investments you can put in your ESA portfolio. Also ask about the broker's fees. Many brokers are out to make as much as possible off of you, so shop around.
Learn about the requirements for ESA's and how you can only invest up to $2,000 in the account per year. This was increased from $500 in the 2001 Tax Relief Act enacted by Congress.
Withdraw money from your account whenever you need it for educational expenses. By law, you can only use this for expenses related to education. And be aware that your contributions to an ESA won't be tax free. However, all earnings accrued from investments are tax free.
Talk to your broker about risks and benefits of 529 plans provided in every U.S. state, or what was once known as qualified tuition plans started by Congress in the mid 1990's. The 529 comes from the IRS code they use to identify this account as tax free.
Work with your broker on picking two options in 529 plans: A college savings plan or a prepaid tuition plan. Both help you invest for college tuition--with the former a tuition fund for any college in the U.S. and the latter designed as a tuition fund for in-state colleges. Choose yours based on whether your child will stay in-state for college or wants to attend in another state.
Check with your broker about how much of your own money your state allows you to put into a 529 plan. Many states allow you to put in well over $300,000 a year if you so choose. Also inquire with your broker or state finance office about all fees that you'll have to pay. They vary by state.
Ask your broker to explain to you the biggest risk of a 529: Tax penalties if you decide to use your fund for anything other than educational purposes. Each state allows you to withdraw and use the money for other things, but the IRS will ask you to pay a 10% penalty fee as well as paying regular federal taxes. Waiving state taxes is a matter determined by the state itself.
Switch your investment option once a year on a 529 plan. Every state allows this and can help if your prior investment isn't giving you fast enough returns. However, most of the stocks and bond investments on 529 plans are non high risk.
Visit your local bank or talk to another broker about opening a Uniform Transfers to Minors Act account or Uniform Gifts to Minors Act account. Both of these are also known as custodial accounts that work simply as a savings account for your child. Start a UTMA account and your child is allowed to invest in real estate or other assets that aren't allowed with a UGMA.
Invest up to $850 in a year and you will not have to pay any taxes on that. If you invest over $950 in the same year, your child will be taxed off the federal tax rate as part of the IRS's Kiddie Tax. Have your child sign the tax forms if he's over 14.
Work with your CPA to pay taxes off any withdrawal you make, which is part of the bitter realities of opening a custodial account.
Learn from your broker that your child, by law, must take control of his UTMA or UGMA account once he turns 18. After that he's responsible for paying his own taxes off withdrawals.