College is expensive. How will you pay?

For the 2013-2014 academic year, a moderate budget at a private college averaged $44,750 and $22,826 for an in-state public college. These costs are expected to increase by 6% annually. At that rate, today’s fifth graders should be prepared to pay $305,000 for a private, and $110,000 for a public, college education. With these costs, it is critical to start planning and saving early if you hope to fund, or even meaningfully contribute to, your children’s college educations.

There are various vehicles available for education savings, many of which are tax-advantaged. To begin, “529 Plans” are state-run education savings plans. You can contribute up to $300,000 per beneficiary to most plans and select from a variety of investment options for the funds. Although contributions to the plan are non-deductible, investment earnings are never taxed, as long as they are used for qualified higher education expenses, such as tuition, fees, books, and room and board.

New York and Connecticut, among other states, offer state tax deductions for contributions to in-state 529 Plans. The funds can be applied to education in any state, but, if you live in one of these states, you can deduct up to $5,000 per year by as an individual and up to $10,000 per year as a married couple filing jointly. If you live in a state that does not offer a deduction for plan contributions, such as Massachusetts or California, you should shop around for the state program which best meets your investment wishes since you won’t be benefitting from the state deduction anyway. Morningstar provides a comparison of every state’s 529 Plan, including advantages and disadvantages of each plan.

Similar to the 529 Plan, the Coverdell Education Savings Account (ESA) accepts non-deductible contributions that grow tax-free. A significant advantage of the Coverdell, as compared to the 529 Plan, is that funds can be used for college, graduate school, or K-12 qualified expenses, including tuition and fees for private elementary school. Each individual can have up to $2,000 contributed per year on their behalf. Unlike the 529 Plan, there are income limits to who can contribute to a Coverdell. So it may take extra planning to take full advantage of the plan.
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