There are several types of savings accounts that can help you and your child prepare for college expenses.
To encourage savings for future education expenses, Congress created Coverdell Education Savings Accounts (ESAs) where annual contributions can grow tax free and those earnings can then be withdrawn when needed for the beneficiary's education expenses. Contributions to an ESA can be made on behalf of a child under age 18. Contributions are not tax deductible, but withdrawals can be made tax free if used to pay for eligible education expenses.
Section 529 Plans are state college savings programs, including prepaid tuition plans, that allow funds to grow tax free for the purpose of paying for certain future college expenses. Plan funds may be used to pay for tuition, fees, supplies, books and room and board costs. Withdrawals taken from 529 Plans for educational expenses are free from federal income tax. Since plans differ from state to state, you should review your state's 529 Plan.
A custodial savings account is an account that a parent, guardian or relative establishes for a child and retains control of until the child reaches the age of majority. These accounts can easily be established under the Uniform Gift to Minors Act (UGMA) or the Uniform Transfer to Minors Act (UTMA). Once established, the account is secure until the child is legally old enough to access it and withdraw funds. The money in a custodial savings account is considered an asset, so it may impact financial aid eligibility.
Other savings can include money set aside in traditional savings accounts, certificates of deposit and money market accounts.
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Consult a financial planner when comparing the benefits of these types of savings accounts. The information above is only a summary of certain IRS tax provisions. Always consult a tax advisor for tax advice. For more information on higher education and income taxes, visit the IRS website at irs.gov, or call the IRS at 1-800-829-1040 (TTY 1-800-829-4059).
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