Benefits of Saving Money for Education

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School costsIt’s Never Too Late to Start Saving for Your Child’s Education

As the cost of education skyrockets, you might be getting nervous about having enough money to send your child to college. The sooner you start saving, the better off you’ll be, especially now that education expenses can start as early as elementary school. However, it’s never too late to start saving for your child’s education. The two most popular plans for doing so are the state-sponsored 529 and the Coverdell Education Savings Accounts (ESA). Which one is best for you? Here are some points to consider:

State-sponsored 529 plans allow you to prepay higher education expenses (college and graduate school) at eligible educational institutions. Some of the advantages are:

  • Your money grows tax-deferred
  • You can use it to pay for tuition, fees, room and board, books, supplies and equipment
  • Funds can be used at any accredited college in the U.S.
  • No federal income tax levied on any investment earnings
  • Withdrawals are tax-free if used for education purposes
  • Contributions up to $2,000 may be partially or fully deductible from some state taxes

Rules vary by state as to contribution limits and transferring money from another account into a 529 plan. You can change the beneficiary of the account to another family member, which will come in handy if your child decides not to go to college. As long as the money is used for higher education expenses, the income will remain tax-free.

Coverdell (ESA) is a tax-advantaged investment account designed to encourage savings to cover future education expenses (elementary, secondary or college), such as tuition, books, uniforms, etc. It is similar to a 529 plan in that it allows money to grow tax deferred and proceeds can be withdrawn tax free for education expenses at a qualified institution. Where it differs is in its  definition of qualified expenses: an ESA includes primary and secondary school, not just college and university. Some of the advantages are:

  • Allows almost any investment, including stocks, bonds, and mutual funds
  • Permits withdrawing money tax free for qualified elementary and secondary school expenses
  • Your money grows tax-free
  • Distributions are not subject to state and local taxes in most states
  • Your child or beneficiary will not owe tax on the distributions if they are less than the education expenses at a qualified institution

Another key difference from the 529 plan is that ESAs have lower maximum contribution limits. By the end of 2012, the maximum contribution limit is scheduled to be reduced to $500 per year. 529 plans generally have no restrictions on contributions, up to the maximum lifetime contribution.

Decisions, decisions

If neither the 529 plan nor the ESA appeals to you, there are other options available, such as college tuition tax credits, which is an amount you’re allowed to subtract from what you owe in taxes, or custodial accounts, wherein wealth is transferred to a minor. While all plans have their advantages, the best one for you depends on your objectives and circumstances. When you compare plans, compare the various options, fees and state tax implications. As with any tax-related decision, you should consult your financial advisor. But don’t delay! Education costs will only continue to rise.

What are your experiences in saving for education? Do you prefer a 529 plan to a Coverdell ESA? Please comment below.