Saving for College without Uncle Sam Taking a Cut

Building a portfolio for a child’s future college costs is important, but why give the government a slice of the money being squirreled away? There are several available plans that are tax-free and make saving for education easy.

Some of the most popular savings vehicles are the 529 College Savings Plans. Although the 529 options vary by state, there are two types of 529s: a prepaid plan and a more traditional savings plan.

The prepaid plan is lucrative for many parents, as it has a higher earning potential than a savings account or CD. Parents buy units of tuition at current prices and will be able to use them when their child goes to college, even if the cost of tuition has risen. So if parents buy units for 75 percent of their child’s educational expenses, they would only have to come up with another 25 percent at the higher rate.

Parents do have to use the credits at a public university in the state they bought them. If the child decides to go to a private university or not to go to college, parents can transfer the money into another child’s name or, if they want to, go back to school themselves – all tax-free.

The other 529 plan resembles a savings account or CD, but like the prepaid option, the money is transferable, so it offers more flexibility than other plans and does not impact a student’s financial aid status. Each state offers different options and some charge higher fees, but all 529 savings plans offer the flexibility for parents to choose where the money is invested.

Although the 529 plans are popular, some opt for the Coverdell Educational Savings Account, another tax-free choice. These are covered under tax code 530, rather than 529. The Coverdell Accounts resemble the 529 plans, but there are some important distinctions. First, money invested in a Coverdell does not have to be used for college education. It can be used for primary and secondary education as well. Also, a yearly limit of $2,000 can be invested, unlike a 529 which has no annual limits up to a lifetime limit. Coverdell’s yearly limit can seriously impede investment opportunities, especially for families that have more financial resources.

Saving for education is crucial for the future of any child, but finding the right tax-free savings plan is no longer daunting. Any of the plans above, or the right mixture of them, should fit the needs of families while making sure the money is going towards their child’s education and not Uncle Sam.

This freelance journalist writes about scholarship searches and tips on saving for education. They also have a Sallie Mae student loan.