How To Streamline College Savings Plans

Many parents these days start early on their children's college savings. We started thinking about our daughter's college costs when she was about three days old. You know it's expensive now to send a child to school. You also know that the price is only going to go up. So you start saving money a little at a time, hoping it will pay a good chunk of the cost. But how can you make that money go even further? There are many options for saving college money---and streamlining your savings into a specialized account can really boost your bottom line.

Qualified Tuition Programs or 529 Plans

Based on Section 529 of the Internal Revenue Code, a 529 plan is a savings plan that is run by a state or educational institution and designed specifically to help you set aside money for future college costs. Federal tax law provides special benefits for the person participating in the plan. These plans are generally categorized as prepaid or savings, but some elements cross over from one category to the other. Every state has at least one 529 plan at this point. Educational institutions can offer 529 prepaid plans (not the savings type of plan). Many people are under the impression that if they use a 529 plan, their child will have to attend an in-state public school, but this is not the case. States that offer prepaid tuition contracts that cover in-state tuition will let you transfer the value to private and out-of-state schools.

The only caveat is that you might get penalized and not get the full value of your contract, depending on which state you live in. This is something you'll have to hash out with your child when the time comes. Under a 529 savings program, the full value of the account can be used at any accredited college or university nationwide. The 529 plans offer the best income tax breaks. Your investment will grow tax-deferred. Distributions to pay for college will come out federally tax-free (your state might offer some tax breaks as well). More good news: You can save a lot of money under a 529 plan---a lot.

Anyone is eligible to use this type of plan, and you can put in more than $300,000 per beneficiary in many of the state plans. Roth IRA Account This is a pretty inexpensive and simple way to save money for college without paying a heavy tax penalty. The money you put into a Roth IRA account is after-tax money, but it' will grow on a tax-free basis once it's in there.

More good news: Any withdrawals you make to pay for higher education are not subject to the 10 percent penalty the IRS imposes on early withdrawals. Coverdell Education Savings Account (ESA) Formerly known as the Education IRA, the Coverdell ESA is similar to a Roth IRA account. In addition to allowing you to save for college, the money in this type of account can also be applied to elementary and secondary school expenses. Unlike the 529 accounts, there are eligibility requirements for the Coverdell ESA, so not everyone can use it. Tax law prohibits ESA funding once the beneficiary is 18 years old. There is a contribution limit of $2,000 per child.

You can't refund the money back to yourself if you don't use it for college (as you can with most 529 plans). The money will automatically be distributed to your child. In addition, some ESA benefits are set to expire after the year 2010, when K-12 expenses will no longer qualify and the contribution limit will return to $500. Like a Roth IRA, the ESA allows you to make annual non-deductible contributions to a specially designated investment trust account, which will grow free of federal income taxes. Other Options There are many other, commonly used options for saving for college.

Here's a brief look at a couple:

• Traditional Savings Account: Many people still sock money away into a regular savings account. This is probably the easiest way to go, but it's also not the smartest. The interest rates are low, so the money's not going to grow too rapidly. And unless you put the account in your child's name, using his or her social security number, you're going to pay taxes on any interest you earn.

• U.S. Savings Bonds: The good news is that EE and I bonds purchased since 1989 can be redeemed tax-free to pay for college tuition and fees of a dependent or spouse, depending on your income level. Still, you'd be better off going with a 529 plan or one of the other, quicker-growing savings plans.

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