Parents today are looking for any possible way to offset the high costs of college tuition. Education savings accounts are a relatively new tax-advantaged investment vehicle allowing family members to set aside funds for their children or grandchildren to use as tuition in the future. There are two popular federal and state sponsored plans that make saving for college easy: the Coverdell and the 529 plan.
529 education savings accounts are sponsored by the state and offered by all 50 states and the District of Columbia. Money contributed into the plan is not tax deductible, but all withdrawals will be if they are used for certain tuition expenses. These expenses generally include tuition, books and room and board. An easy way to think about a 529 savings plan is as a 401(k) dedicated to educational expenses. As with a 401(k), there are many different investment choices. Many states programs are open to nonresidents, so look around for the best plans.
Prepaid tuition education savings accounts let you to purchase units of tuition for any state college or university under today’s rates. You can buy a semester of attendance for a child at a time. What you buy today will be good for any future date, no matter how tuition rates rise. With private and out-of-state colleges, the child’s prepaid tuition does not include the rise in tuition costs. For instance, if you buy two years of college tuition for an out-of-state tuition, you may only receive a single semester in ten years.
Another type of education savings account is the Coverdell plan, which is federally sponsored plan. You can set aside funds for future education expenses, such as tuition, fees, books, supplies, and sometimes room and board. The annual contributions are not tax deductible, making the withdrawals tax-free as long as they are used to pay for eligible education costs. There is a $2,000 limit on the amount of annual contributions that can be made each year.
A child may have as many Coverdell accounts as you wish. For example, you could have one account at your local bank and one at a brokerage. Some plans have many fees associated with them. Make sure that the management fees for the multiple accounts don’t cancel out your overall return. If your child decides not to go to college, he or she will lose a great deal of money. When he turns 30, he must withdraw the balance of the account within 30 days. Any money withdrawn that isn’t used for educationally eligible expenses is taxed and charged a 10 % IRS penalty.
