529 Plans
One way to save for college and other eligible educational expenses is through a qualified tuition program, also known as a 529 plan. Typically established and maintained by a state or an agency of a state, 529 plans provide opportunities for you and family members to contribute to future educational costs—including college tuition and qualified education expenses for higher education and private elementary and secondary education—and receive tax advantages.
There are two types of 529 plans: prepaid tuition plans and savings plans. Both allow earnings to grow tax-deferred, and withdrawals are tax-free when used for qualified education expenses, with some limitations. Prepaid plans also offer protection against rising tuition costs.
Most states offer at least one of these types of plans. Some states offer both, and many private colleges also offer a prepaid tuition plan.
Learn more about the differences between 529 savings and prepaid tuition plans to decide which type will best help you achieve your college savings goals.
Coverdell ESAs
Coverdell Education Savings Accounts (Coverdell ESAs) are a type of trust or custodial account that offers a tax-advantaged way to pay for education. Coverdell ESAs offer broader investment options than 529 plans, but contributions are limited. Custodial accounts allow a parent, grandparent or other custodian to make investment decisions until the child for whom the account was opened—the beneficiary—reaches a specified age.
As with 529 plans, contributions are not tax deductible. However, earnings in Coverdell ESAs are tax-deferred, and withdrawals that are used to pay for qualified education expenses are tax-free.
One advantage that Coverdell ESAs have over other tax-advantaged saving options is that you can make tax-free withdrawals to pay for eligible elementary and high school expenses (e.g., special needs services, tutoring and private school tuition), as well as post-secondary school expenses.
Except for investing in life insurance contracts, there are no investment restrictions for funds in a Coverdell ESA. You can set them up at almost any brokerage firm, mutual fund company or other financial institution. Keep in mind that, because of Coverdell ESAs’ fairly low contribution limits, even small annual fees or expenses could make a big difference in the value of your investment over time.
Savings Bonds
Series EE savings bonds issued after 1989 or Series I saving bonds are another tax-advantaged way to save for education. Backed by the full faith and credit of the United States government, the interest from these bonds is tax-free if used for qualified higher education expenses. Also, interest on Series EE and Series I savings bonds is usually exempt from state and local taxes.
The rules for using savings bonds for education can be complicated, and income limits apply (see IRS Publication 970: Tax Benefits for Education). Find the latest rates and other information about Series EE and Series I savings bonds at TreasuryDirect.
UGMA and UTMA Custodial Accounts
While not solely intended for college savings, Uniform Gift to Minors Act (UGMA) or Uniform Transfer to Minors Act (UTMA) custodial accounts can also offer an avenue to save for education. Like Coverdell ESAs, with an UGMA or UTMA, a parent, grandparent or other adult is custodian for the account and makes all the investment decisions until the account beneficiary reaches the age of majority.
UGMA and UTMA accounts are largely the same, but the kind of assets you can contribute to them differs. UGMA accounts are limited to gifts of cash, securities (such as stocks, bonds or mutual funds) and insurance policies. UTMA accounts allow for the contribution of virtually any kind of asset, including real estate. Some states allow UTMA accounts, while others allow UGMA accounts. You can set up these accounts at almost any brokerage firm, mutual fund company or other financial institution.