Consider Tax-advantaged Savings To Keep Up With College Costs

NEW YORK (MarketWatch) -- Even if you've been diligently saving a portion of every paycheck for your child's college education, it may not be enough when the time comes, warns Alyce Zollman, a New York-based financial consultant for Charles Schwab. Over the past 20 years, college tuition and fees have gone up an average 8.7% annually, says the Department of Labor, and there's every indication that this upward trend will continue.

To ensure that your money keeps pace with rising prices, Zollman urges parents to consider two tax-advantaged investment programs: 529 plans and Coverdell Education Savings Accounts.

529 plans

529 plans are state-sponsored programs that allow parents, relatives and even friends to put money towards a child's future education. They work much like IRAs in that your assets grow tax-deferred. They also offer the highest contribution limits. The rules governing 529 plans vary from state to state, but the lifetime limits generally hover around $200,000.

The assets in your 529 plan can be invested in actively managed mutual funds or index funds, based on your preference, allowing you to control the level of risk. Zollman is a strong advocate of "age-based portfolios," 529 plans that are professionally managed to limit the risk of heavy losses the closer your child gets to matriculation.

Most important: Any withdrawals you make from a 529 plan, once your young adult has entered college, are tax-free -- as long as the money is put toward qualified expenses of higher education.

Coverdell Education Savings Accounts

The major downside of 529 plans, says Zollman, is that they are exclusively geared toward college expenses. For those parents interested in putting money away for elementary and secondary school, Zollman suggests Coverdell Education Savings Accounts. Like 529 plans, the money you put in Coverdells is untaxed at withdrawal, but they offer more leeway in that the money can be put toward education at any level.

Visit your state government's Web site or speak with your financial planner for further information on 529 plans and Coverdell accounts.

By Marshall Loeb