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Lane Keeter, CPA

Partner: Tax Consulting, Estate Planning, and Heber Springs Managing Partner

Tax Breaks That Can Impact College Savings Plans

The numbers can stagger the mind!

According to the College Board, a "moderate" budget for sending your kiddo to a four-year public college for the last academic year was $24,610.

Have something more upscale in mind for Baby Einstein? Average cost for a four-year private school was $49,320, according to the organization.

It's ok to swallow hard here!

So with that in mind, short of being Daddy Warbucks, how will you pay for your child's education? And what if your "quiver is full" (random Psalm reference) with more than one?

No one ever said paying for a college education would be as cake walk. But with help of the tax code, families have a few options and greater flexibility for paying for college. The important thing is to get started saving for college as early as possible.

When thinking about saving for college, it's indeed possible to hide away money for college in a savings account, a CD, a custodial account or a mutual fund, but these ideas may not be your best option because they're all taxable.

A better alternative, due to tax advantages, might be "529 Plans". 529 Plans, also known as "qualified tuition programs" have emerged as one of the best opportunities to invest for higher education because of the federal and state tax-free withdrawal possibilities.

529 plans allow families to save for college by making contributions to an account set up for a prospective college student. The plans are hosted by a state or educational institution, but professionally managed by an investment firm.

The student can use the money at just about any accredited college or other institution of higher learning in or out of the state of residence. Families aren't limited to their own state's plan, although some states, like Arkansas, allow a state tax deduction for contributions made to that state's plan.

Withdrawals for qualified education expenses are completely free of income tax, including any income the plan has earned over time.

And here is a financial planning tip: The balance in a 529 plan is considered a parental asset for purposes of determining financial aid. That means it has much less effect on how much financial aid a college will offer than does an asset held in the student's name.

You can contribute to a 529 plan for as long as you want. There are no age requirements or deadlines for using the money either. The plan can be transferred to another family member if the original beneficiary doesn't go to school, or funds can be returned to the contributor (who would pay a tax penalty).

Another savings opportunity, albeit more limited one in terms of the amount you can put away, is the Coverdell education savings account, often referred to as an education IRA (although they are not related to individual retirement accounts).

Like 529 plans, they too are attractive because of potential tax savings on income earned in the account. The annual contribution limit, however, is only $2,000, and that limit is subject to phase-out if your income is too high. Phase-out eligibility limits are $190,000-$220,000 in modified adjusted gross income if you are married filing joint, and $95,000-$110,000 for other filers.

One nice advantage these accounts have over 529 plans is that parents can withdraw money from them tax-free for elementary and secondary education expenses, such as tuition, books and equipment at public, private or parochial schools.

Another advantage is that you have complete control over the investments held in the account, the options of which are as great as any taxable investment account. This is different than 529 plans, the investments in which are restricted to only what the plan offers.

Much like an IRA, your contribution for a particular year can be made up until April 15 of the following year. But unlike regular IRAs, contributions to education savings account are not tax-deductible.

Unfortunately, there are some other disadvantages too. Contributions cannot be made after the beneficiary turns 18. Any balance left in the account after the beneficiary turns 30 goes to the beneficiary. And once you make a contribution, you cannot reclaim the money, as you can with a 529 plan.

It also should be noted that it's entirely possible to contribute to both a Coverdell account and a 529 plan in the same year for the same beneficiary. You can also make withdrawals from both in the same year, although you will have to allocate the qualified education expenses between the two.

Coverdell education savings accounts and 529 plans are effective college savings tools, that when used wisely, can greatly relieve what may seem like an overwhelming burden of paying for your child's education. And they are great for use by grandparents as well!

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