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Save for College With a 529 or Coverdell ESA Plan

One of your primary responsibilities when you welcome a child into the world is preparing them for adulthood. Of course you feed them, clothe them and house them. You make sure they have a good education, and you instill in them a solid sense of right and wrong.

Many families, though, want to go a little further and save for a child entering adulthood. These savings are typically in the form of a college fund, but that’s not the only choice. There are ways to prepare early for a child’s wedding, their first home, or even a mission trip overseas. The direction you take will depend on your resources, your location and the likely end use of that money.

When College Is the Goal

Do you come from a family where higher education is the norm? Are you personally committed to seeing your child go to college? If so, you’ll want to plan for college expenses.

The upside of saving for college is that you know when you’re going to need the money. The downside is that you have to begin at a time when your finances are already stretched tight with a mortgage, car payments, groceries and all the other costs that come with raising a family.

Yet the earlier you start, the less of an uphill battle you’ll face. College costs rise faster than just about any other area of the economy, with the possible exception of health care. To put it bluntly, when you save for college, you are fighting inflation. Fortunately, there are ways you can save without having to pay taxes on the growth of your money.

529 Plan

The first is called a 529 plan, which is organized by your state and named after section 529 of the Internal Revenue Code (26 U.S. Code § 529). Typically your state will team up with an insurance company or mutual fund company to help pick investments within the plan. Because they are state plans, you need to look into the details for your state. For example, some states offer tax credits for investments made into the plan, while others don’t. (For related reading, see: 529 Plans: Introduction.)

Coverdell Education Savings Account

The other major college investment tool is known as a Coverdell Education Savings Account (ESA). These plans are covered by section 530 of the Internal Revenue Code (26 U.S.C. § 530).

ESAs are another way to grow your money tax-free. The main advantage they offer over a 529 plan is that they let you invest in a wide range of stocks and bonds (if the custodian allows). In a 529 plan, your choices are typically limited to mutual funds. The disadvantage of an ESA is that you’re limited to an annual investment of $2,000. (For related reading, see: Clearing up Tax Confusion for College Savings Accounts.)

So, for instance, if you’re investing $150 each month, you might pick an ESA, but if you have grandparents and other family members kicking in, you might go with a 529 plan. Or if your situation is a little different—and many, many situations are—you might be interested in a hybrid approach.

These are just a few options you may want to consider for saving for college. Consult your financial professional to help you make the absolute best decision for your family’s situation.

(For more from this author, see: Secure Your Financial Future With These 3 Steps.)

Disclaimer: Heritage Investors, LLC, 11470 Parkside Dr Suite 201, Knoxville, TN 37934, (865) 690-1155, is registered as an investment adviser with the State of Tennessee. Heritage Investors only transacts business in states where it is properly registered or is excluded or exempted from registration requirements.