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Planning for your child’s college education can be a daunting task. The cost of tuition at public and private colleges keeps increasing every year. If you don’t start saving now, you may not be able to afford the college of their choice later on.

There are two types of college savings accounts available to you. Both of them come with certain tax advantages: 529 Plans (also known as Qualified Tuition Programs) and Coverdell Education Savings Accounts (previously known as Education IRAs).

529 Plan

How it Works

529 Plans are named after the section number of the IRS code in which they are described. Each state has its own version of a 529 plan. Depending on the state you reside in, you will have either or both of these options:

1. 529 Prepaid Tuition Plan. You prepay future tuition at today’s rates. This type of 529 plan is guaranteed to increase in value at the same rate as college tuition.

2. 529 College Savings Plan. Contribute to an investment account to save money for future education expenses. You won’t have to pay any taxes on the earnings in your account and qualified withdrawals are tax-free. In addition, qualified education expenses don’t just include tuition but also room and board, books, supplies, and any equipment needed for school.

Note: You can’t deduct prepayments or contributions to a 529 Plan on your tax return.

Contribution Limits

There are no income restrictions on who can participate in 529 plans. However, the amount you can contribute to a plan cannot be more than is necessary to pay for qualified education expenses. The exact contribution limits vary by state.

Coverdell Education Savings Account

How it Works

Coverdell Education Savings Accounts, or Coverdell ESAs, are similar to 529 College Savings Plans. You won’t have to pay taxes on your earnings (i.e. interest, dividends, capital gains, etc.) now or later when you withdraw the money to pay for your child’s qualified education expenses. Qualified education expenses include not only tuition but also room and board, books, supplies, and equipment needed for school.

Note: The contributions to a Coverdell ESA are not tax-deductible.

Contribution Limits

In order to contribute to a Coverdell ESA, your modified adjusted gross income (MAGI) must be less than $110,000 ($220,000 if filing a joint return). For most taxpayers, MAGI is the same as adjusted gross income reported on their federal income tax return.

In addition, total contributions to a Coverdell ESA cannot exceed $2,000 per beneficiary per year (as of 2009). The beneficiary is the child that the ESA was set up for.

Photo Credit: koyochi

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