Paying for college has grown incredibly expensive—far outstripping the rate of inflation. According to the College Board, a student entering college in the year 2020 will pay more than $85,000 at a public university for a four-year education, and a whopping $225,000 at a private college. That’s a lot of money. Fortunately, the government has created several methods to help you save enough for college for your children or yourself.
Coverdell ESAs (short for Education Savings Accounts) are named after a late U.S. Senator who helped create the program. A Coverdell ESA is much like a Roth IRA except that it is used only for education expenses. Here’s how it works.
529 savings plans are named after Section 529 of the tax code—the provision that establishes them. They are also called Qualified Tuition Programs or QTPs for short. 529 savings plans are more complicated then Coverdell ESAs, but you can contribute much more money to them. They have become very popular with parents in recent years, but you should do careful research before you invest in one.
529 savings plans are very different from Coverdell ESAs. First of all, unlike other tax-advantaged accounts, 529 plans must be sponsored by state governments or state agencies. Every state has some type of 529 plan; some have several. However, the states do not actually run the plans. Instead, they enter into agreements with investment companies to operate them—these firms manage the investments in the plan. You must pay annual management fees to the investment company—part of which go to the state—which makes 529 plans a big moneymaker for state governments. Here’s how 529 savings plans work:
United States savings bonds may not be as sexy as 529 plans or Coverdell ESAs, but they can be a good way to save for college. The interest earned on U.S. savings bonds is not subject to state or local taxation, but it ordinarily is subject to federal income tax. If you do not include the interest in income in the years it is earned, you must include it in your income in the year in which you cash in the bonds.
Certain bonds issued under the Education Savings Bond Program—Series EE and Series I—may be cashed in without paying any federal or other tax on the interest if the money is used to pay tuition and fees to enroll yourself, your spouse, child, or other dependent at any accredited college, university, or vocational school. Only Series EE bonds purchased after 1989 qualify for tax-free treatment (Series I bonds are not subject to this rule). The bond must be issued either in your name (as the sole owner) or in the name of both you and your spouse (as co-owners). The bond owner must be at least 24 years old before the bond's issue date. The issue date is printed on the front of the savings bond. In addition, there is an income limit to qualify for tax-free treatment of the interest.