According to The Institute for College Access & Success, ‘two-thirds of college seniors graduated with loans in 2010, and they carried an average of $ 25,250 in debt.’[i]  Though college costs continue to rise, there are several ways the fund college.  Many generous donors have set up scholarship funds to help qualifying high school graduates pay for college. You should examine what scholarships are available in the states and at the various universities you are considering.

And many students qualify for grants, such as Pell Grants or Fulbright Grants, which often pay a significant portion of college expenses.  Additionally, students use Federal Student Aid (FAFSA.ed.gov for a free application) or Private Student Loans.  However, if you are looking to save money to help fund the cost of college for a child, then you might consider using a 529 plan and or a Coverdell Education Savings Account (ESA).

• 529 SAVINGS PLANS:

A 529 plan is a tax-advantaged saving plan specifically designed to encourage saving for future college costs.  Section 529 of the Internal Revenue Code set up tax-favored status for Qualified Tuition Programs (QTPs); according to IRS Topic 313: “a …QTP also called ‘529 plan,’ formerly called a Qualified State Tuition Program (QSTP), is a program established and maintained by a state, or agency …of a state, to allow either prepaying, or contributing to an account established for paying a student’s qualified higher education expenses… generally any college, university, vocational school… eligible to participate in a student aid program administered by the Department of Education.  Contributions to a QTP …cannot be more than the amount necessary to provide for the qualified higher education expenses… Contributions …are not deductible on your Federal tax return.  The benefits of establishing a QTP are; earnings accumulate tax free while in the account, and no tax is due on a distribution that is used to pay qualified higher education expenses…”   Note: If you withdraw money from a 529 plan and do not use it towards qualified higher education expenses then you will likely be subject to income tax and an additional 10% federal penalty.

• COVERDELL EDUCATION SAVINGS ACCOUNTS:

According to IRS Tax Tip 2008-59, “A Coverdell Education Savings Account (ESA) is an account created as an incentive to help parents and students save for education expenses.  The total contributions for the beneficiary (student under age 18) of this account cannot be more than $ 2,000 in any year, no matter how many accounts have been established…  Contributions …are not deductible, but amounts deposited in the account grow tax-free until distributed. The beneficiary will not owe tax on the distributions if they are less than a beneficiary’s qualified education expenses at an eligible institution… If the distribution exceeds qualified education expenses, a portion will be taxable to the beneficiary and will usually be subject to an additional 10% tax.  Exceptions to the additional 10% tax include the death or disability of the beneficiary or if the beneficiary receives a qualified scholarship.  …If there is a balance in the Coverdell ESA when the beneficiary reaches age 30, it must generally be distributed within 30 days…”

The Coverdell ESA offers a little more flexibility than the 529 plan, including more choices in investment options.  However, high-income earners making more than $ 110,000 (single) or $ 220,000 (married) cannot take advantage of this tax advantage plan.  But more importantly, unless Congress grants another extension, on January 1, 2013, these ESA plans will only qualify for post secondary education expenses; and the annual contribution limit will be reduced to $ 500 per beneficiary.