There are no two ways about it: college is expensive. Though it can be daunting to save up enough, the earlier you start, the more likely you are to reach your goal. Using a tax-advantaged plan, such as a Coverdell education savings account or 529 plan, can help you pay for your son's college. Some people even pay for college using an individual retirement account.
Making contributions to a Coverdell allows the money to grow tax-free in the account and, assuming you use it for qualified educational expenses, you can take it all out tax-free. Coverdells also offer flexibility because qualified expenses include grade school and high school, not just college expenses. However, contributions can only be made if your modified adjusted gross income falls below the annual limits -- $220,000 if you're filing a joint return or $110,000 if you're single -- and no beneficiary can receive more than $2,000 in contributions per year. Plus, the money must be spent by age 30, otherwise you're forced to take a non-qualified withdrawal, which means the income portion is taxed and hit with a 10 percent penalty.
College Savings Plans
The first variant of 529 plans is a college savings plan, which allows you to invest money in a tax-sheltered portfolio offered by a state or state agency and then take tax-free distributions for qualified educational expenses. Though you can only use 529 plan proceeds for college or graduate school without penalty, there's no age limit or deadline on when the money must be spent, and you can contribute up to the amount reasonably necessary to pay for college -- which could be well into the six figures.
Prepaid Tuition Plans
Prepaid tuition plans are the other option within the 529 plan category. Instead of investing, you purchase credits for tuition at today's prices and then your son can use them at any of the schools in the group participating in the plan when he's ready to go to college. Though you might think there's no way to predict where you son will go when he's so young, some prepaid plans allow you to use the credits at a range of schools. For example, the Private College 529 plan has more than 270 participating schools.
Individual Retirement Accounts
Although obviously most people use an IRA to save for retirement, an IRA -- especially a Roth IRA -- can also offer a way to save for college. With a Roth IRA, your contributions aren't deductible, but the money grows tax-free and when you hit 59 1/2 you can take out as much as you want tax-free. Even though your son might be headed off to college before you hit 59 1/2, there's an exception to the early withdrawal penalty for funds withdrawn to pay for higher education expenses. Plus, if you're using a Roth IRA, you get your contributions back tax-free first, so you might not even touch the earnings. Just don't double count your savings -- if you're counting on your IRA to pay for college, you need to be saving money elsewhere, such as your 401(k), for your retirement. However, as of 2013, you're limited to an annual contribution of just $5,500 to your IRA.
- Internal Revenue Service: Publication 970 -- Tax Benefits for Education
- Private College 529 Prepaid Plan: Participating Schools
- Securities and Exchange Commission: An Introduction to 529 Plans
- USA Today: Is a Roth IRA or 529 Plan Better When Saving for College?
- Internal Revenue Service: IRS Announces 2013 Pension Plan Limitations
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