Many new parents start a savings fund to pay for their children's education early on, with some opening an account immediately after their first son or daughter is born. While traditional savings remain a common and popular way to cover tuition expenses, there are also accounts that offer tax-advantaged savings.
One of the most widely-used accounts is the 529 college savings plans. Named for the Internal Revenue Code section under which these education savings programs were created, 529 plans allow parents to make non-deductible contributions to the account, which accumulate tax-free. In the future, funds that are withdrawn specifically to cover qualified education expenses are not taxed.
These accounts are administered by states, rather than the federal government, meaning that the rules and benefits of each type of program may vary. However, parents are not required to invest in their particular state's program, and students are not required to attend college in the state that administers the plan. This means that parents who live in California may invest in a 529 plan administered by Washington, and send their child to school in North Carolina. For this reason, it's important that parents compare plans of different states to find the one that is the most favorable to their needs.
Coverdell education savings accounts may be another option for parents. These accounts work similarly to 529 plans in that contributions are not deductible on federal taxes, but distributions are tax-free if used for qualifying expenses. In addition, any individual can contribute to a beneficiary's Coverdell account, but the maximum contribution is $2,000 from all individuals, not $2,000 per person. In addition, there are income restrictions on contributors. The ability to fund a Coverdell account phases out for single filers with modified adjusted gross incomes between $95,000 and $110,000 and married joint filers with an MAGI between $190,000 and $220,000.
However, Coverdells are attached to the Bush tax cuts, and the rules regarding these accounts may expire on December 31, 2012, if not renewed by Congress.
New parents who are considering establishing an education savings program for their children may benefit from discussing their options with a tax preparer. These professionals can help them navigate the income rules and other restrictions that may impact parents' decisions.
Liberty Tax Service provides computerized income tax preparation and electronic filing. Each tax office offers customers audit assistance, a money back guarantee, and free tax return checking.
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