IF YOU'VE GOT college-bound kids, then you're probably already painfully aware that the cost of college is staggering — and rising. Mercifully, Washington has delivered some valuable tax breaks to parents trying to foot the bill.
Here's a look at what's available.
State-Sponsored College-Savings Plans ("Section 529 Plans")
Section 529 college savings plans are a great deal because they offer tax-free withdrawals for the account beneficiary's qualified college costs. If you can afford to make substantial contributions while your kids are still young, you should be sitting pretty by the time Junior heads off to school.
Most college-savings plans now permit lump-sum contributions of well over $100,000 and typically offer several investment options. Most plans also welcome out-of-state investors. They allow payouts for costs to attend any accredited college or university in the country. You should shop around to find the Section 529 college-savings plan you like best, keeping in mind your in-state program may offer state-tax advantages that tip the scale in its favor.
When searching for a plan, don't confuse Section 529 college-savings plans with Section 529 prepaid college-tuition plans. They are both termed "Section 529 Plans" because they're permitted by the same Tax Code section. Here's the difference. Prepaid tuition plans simply allow you grow your money at the rate of tuition inflation at designated schools (typically in-state schools) and offer you no control over how the money is invested. By contrast, a savings plan allows you to decide how the account is invested, based on the plan options.
Coverdell Education Savings Accounts (CESAs)
With a Coverdell Education Savings Account (formerly called an Education IRA), you can contribute up to $2,000 per year per child. Annual contributions are allowed up until the account beneficiary turns 18, and the earnings build up tax-free.
At the appropriate time, the money can be withdrawn (also tax-free) to pay for the account beneficiary's college expenses. Like contributions to Roth IRAs, CESA contributions are nondeductible, but the tax-free withdrawal privilege makes up for that. If the beneficiary doesn't incur enough expenses to exhaust his or her account, the balance can be rolled over tax-free into another family member's CESA.
In addition to college expenses, CESA payouts can be used toward the account beneficiary's elementary and secondary school (K-12) costs. Eligible expenses include tuition and fees to attend private and religious schools, room, board, uniforms and transportation. You can also withdraw CESA money tax-free to pay costs to attend public K-12 schools. Eligible expenses include books and supplies, academic tutoring, computers, peripheral equipment and software and even Internet-access charges.
If you're unmarried, your ability to make CESA contributions is phased out between adjusted gross income of $95,000 and $110,000. For joint filers, the phase-out range is $190,000 to $220,000.
