Boning Up on Saving for College

A college degree has never been more important to financial success, and the rising price of tuition suggests that many folks are in agreement. The good news is the government has thrown us some serious tax breaks — you just might need a degree in accounting to figure out which is the best way to go. Regardless of HOW you save, you will need to start saving early or face a new kind of cram session.

Expect to pay a lot. In recent years college tuition rates have been rising faster than the rate of inflation. If you have an infant who you plan to educate, be on guard that by the time they are college age, four years at even a moderately priced university could cost $150,000 or more.

There are two terms you need to know when saving for college. One is a Coverdell Education Savings Account the other is a 529 Plan. There are other approaches to saving for college (for instance, a savvy investor might do better in a simple brokerage account or you might want to legally gift money to your child so it can grow at the child's lower tax rate), but these are the two plans designed with education costs in mind.

529 plans

529 plans are college investment plans run by a state or an institution. You'll have some options, but the funds are managed much like a 401k. Your money will grow in the plan tax deferred and the money you remove for qualified education expenses will be tax exempt. There are no income restrictions and you can put $200,000 and sometimes more in them for your child's college education. Watch out, though, monies not used for education will be hit with a 10% penalty on the way out.

529 pre-paid plans

Yes, there are two kinds of 529s. Pre-paid plans aren't really savings plans at all. Participants are basically buying education on lay away. The attractive thing is that you can usually "buy" at a discount and you can lock in early and avoid tuition rate hikes. The downside is that the eligible schools are limited. Usually pre-paid plans are administered by states and only state residents can use them for in-state schools.

Coverdell ESA

Parents can contribute up to $2,000 per year to a Coverdell Education Savings Account. They can invest it anyway they like and their earnings will be tax deferred and then tax exempt if spent on qualified education expenses. One advantage that Coverdell plans have is that you can convert them to a 529 plan later. 529s however cannot be converted to a Coverdell. One disadvantage is that $2,000 might not amass big enough sums to cover college. However, parents with the wherewithal can do more than one plan.