Tax-Savvy Ways to Save for College

NEW YORK (MainStreet) — The tax code provides several ways to defer or avoid taxes while saving for your child’s education.

For parents or grandparents of newborns or young children, perhaps the best way to save for their college education is with a Qualified Tuition Program, also known as a Section 529 Plan. Contributions to a 529 Plan are not deductible, but distributions are tax free as long as they are used to pay for the qualified higher education expenses of the designated beneficiary. Qualified expenses include tuition, required fees, books and supplies. For someone who is at least a half-time student, room and board also qualifies.

There are no statutory limitations to the amount that can be contributed to a 529 Plan, other than that they cannot be more than the amount necessary to provide for the qualified education expenses of the beneficiary. The amount each person can contribute is based on the annual gift tax exclusion. There is no adjusted gross income or modified adjusted gross income income phaseout — anyone can contribute to a 529 Plan regardless of income or relationship.

What if the beneficiary of the 529 Plan decides not to go to college, or gets a full scholarship? Or if the balance that has accrued in the plan is more than the qualified education expenses of the beneficiary? In such situations you can change the beneficiary to another family member or transfer the money to the 529 Plan of another family member.

You can also save for college using a Coverdell Education Savings Account. Parents and family members can contribute up to a maximum of $2,000 per student beneficiary per year to a Coverdell ESA.

As with a 529 Plan, contributions to a Coverdell are not deductible, but distributions are tax free if they are used for the beneficiary’s qualified education expenses at an eligible institution.