By Steven Zeller

If you’re wondering how you’re going to save enough for your children’s education, you may want to hit the books and learn about the expanded choices to be available next year to help pay tuition and other schooling expenses.

The new legislation increases the annual contribution limit to Education IRAs from $500 to $2,000 per child - i.e., four times the annual amount allowed in 2001. Also, you can now use the balance in these accounts to pay for elementary and secondary school expenses - including tutoring, after-school latchkey programs, room and board, and computer equipment - in addition to college expenses. Current law allows coverage for college expenses only.

In addition, key provisions in the new legislation affect 529 plans, also known as Qualified State Tuition Plans. The most significant improvement is a provision that makes qualified withdrawals from 529 plans federal-income-tax-free starting in 2002. In some cases, withdrawals may be exempt from state taxes as well. In addition, the new law allows one tax-free transfer within a 12-month period from one qualified tuition program to another, beginning in 2002, for the same designated beneficiary. Currently, the beneficiary must be changed for a transfer to be permitted.

Wealthy investors especially benefit from 529 plans, since the plans allow contributions up to $50,000 per beneficiary in a single year without federal gift tax consequences. No other gifts may be made to the same beneficiary for a five-year period.

Beneficiaries also benefit because since qualified withdrawals are federally tax free, they can pocket more of the cash for school expenses. Under current rules, withdrawals are taxed at the beneficiary’s tax bracket, typically 15 percent.

But how do you decide which plan to use? Savers should maximize their contributions by using both plans, if they can afford it. Current law prohibits investors from contributing to both plans in the same year, but the new law does allow dual contributions.

However, if you are able to contribute only a limited amount to a college-savings plan, you should be aware that Education IRAs may offer more flexibility in investment choices while 529 plan investment options are more restricted. However, 529 plans offer important estate-planning benefits as well as higher annual contribution limits and no age or income limitations.

Finally, investors should be aware of the sunset clause in 2011. If a new law is not passed between now and then, all laws revert back to what they were before this new law was passed. So if your child is only 2 years old now, by the time they reach college age distributions for the 529 plan may no longer be tax free. Proper planning for this possibility will be critical.

Steven Zeller is a financial consultant with A.G. Edwards & Sons., Inc., member SIPC, 379 Lytton Avenue, Palo Alto 94301. The phone number is 326-5010.