You can take advantage of government incentive programs that were originally designed for retirement needs. Now, IRAs can help you finance your child's education and reduce your taxable income.

Roth IRA

If your family qualifies for a Roth IRA, it’s a wise investment because it is extremely flexible. (There are phase-outs if adjusted gross income is between $95,000–$110,000 for single filers, $150,000–$160,000 for joint filers.)

With a $4,000 annual contribution limit (slated to increase to $5,000 in 2008), Roth IRA funds may be withdrawn free of federal income tax (and, in some cases, free of state taxes) to pay qualified education expenses.

For retirement purposes, there are numerous intricate laws that make the comparison of Roth IRA to other forms of retirement savings an ongoing debate.

Traditional IRA

Traditional or classic IRAs have a $4,000 annual contribution limit and can be withdrawn early for education expenses.

While withdrawals are not tax free, contributions into traditional IRAs are tax deductible on both federal and state levels. The only other downside is a low income phase-out if you have a 401(k) through your employer ($32,000–$42,000 for single filers; $52,000–$62,000 for joint filers).

Borrowing from a 401(k)

This is not a favorable strategy because education loans offer more promising features, such as low interest rates and tax deductibility.

For those who have saved faithfully in their 401(k) and have children at or near college age, it is a viable last resort. Be aware, if you leave your current job, the entire loan must be repaid immediately.

Mutual funds

The main purpose in using mutual funds for education savings is the investment flexibility and lack of restrictions on contributions. This is an option for the savvy investor or families with fluctuating and uncertain financial circumstances.

The downside to using a heavy mutual fund strategy is giving up large tax breaks, which could amount to thousands of extra dollars. It may be better to consider a 529 plan instead of the mutual fund approach.