It's never too early to start saving for a college education. It can cost $150,000 or more for four years of college and costs continue to rise. Even with grants and loans, paying for college can strain your family's finances. There are many ways you can save for college but three of the most common options are 529 plans, Coverdell savings accounts and individual retirement accounts.
Start a 529 college savings plan using your state's program; all 50 states and the District of Columbia offer some type of 529 plan. Check your state for limits on how much you can contribute. You can't deduct contributions from federal income taxes; however, certain states offer state income tax deductions for contributions to 529 plans. Grow the 529 with interest or earnings -- which are not subject to taxes. You must use the money only for college expenses or pay a 10 percent penalty.
Create a Coverdell education savings account, which is similar to a 529 plan in that contributions are not deductible but earnings and income are tax-free. Contribute up to the maximum of $2,000 a year. Use distributions from a Coverdell account tax-free for college expenses. You can establish both a 529 and a Coverdell for the same student to increase funds, but you should keep total contributions under the $13,000 to avoid incurring federal gift tax.
Use an individual retirement account to build savings for college. If you are under age 50, you can contribute up to $5,000 a year to a traditional IRA account -- and $6,000 each year if you are age 50 or older. Contributions to a traditional IRA are tax deferred; you pay taxes when you withdraw. You can withdraw money without limits or penalties to pay college expenses; however, you will have to pay income tax on those withdrawals.
- SEC: An Introduction to 529 Plans
- IRS: Coverdell Education Savings Accounts
- Saving for College.com: Coverdell Education Savings Accounts
- The CPA Journal: Rethinking College Savings Strategies
- My Best Jobs: Pay For College with Pre-tax Dollars
- USA Today: 529 Plans Becoming Top Savings Option
- MSMoney: College Planning
- Montgomery Capital Management: College Funding Planning
- Internal Revenue Service: Retirement Plans FAQs regarding IRAs
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