Tax-Deferred Ways to Save for College
Saving money for college (yours or your children’s) is a good thing, even when financial times are tough. Uncle Sam backs up that college-investment philosophy with a variety of savings programs that contain built-in tax incentives. Consider the following:
Section 529 plans: Qualified tuition programs covered under Section 529 of the Internal Revenue Code allow you to save money or purchase tuition credits for future college expenses for a specific beneficiary. Your money goes into an account that’s administered either by the state or by a specific college or university. To make a Section 529 plan work, you have to understand its requirements and follow them, for example:
You’re not allowed any federal income tax deduction for the amount of your Section 529 plan contribution.
Depending on which state you live in (and if you use its plan), you may get a current state income tax deduction for part or all of your contribution each year.
Interest that you earn on the money in a Section 529 plan isn’t taxed until distributions are made to your designated beneficiary. And if you use these distributions to pay the qualified education expenses of a student at an eligible educational institution, accrued earnings generally aren’t taxed at all.
To get these tax benefits, the money must be used for qualified expenses (tuition, room and board, books, and so on) at qualified institutions.
Coverdell accounts: Coverdell education savings accounts (ESAs) also enable you to save now for future educational expenses — whether primary, secondary, or postsecondary — of a designated beneficiary. You can invest money in Coverdell accounts in a variety of ways (stocks, bonds, money market accounts, certificates of deposit, and so on). You pay no income tax on the income when it’s earned, and as distributions are made from these accounts to your designated beneficiary for qualified educational expenses, the income portion of the distribution isn’t taxed.
If you designate yourself the one responsible for all decisions on this particular account, you keep control of the money and make all the investment decisions for the account. Over the years, the investments will hopefully earn significant income.