Take Advantage of Tax-Deferred College Plans

If you're saving to put a child through college right now — or soon will be — your timing is pretty good. In recent years, new provisions in the tax code expanded both the allowable contributions and the uses of tax-advantaged education savings plans. Two plans that should be at the top of your list are the 529 Plan and the Coverdell Education Savings Account; state prepaid tuition plans are also worth looking into.

If you have your retirement house in order, or can afford to make contributions to both efforts simultaneously, by all means take advantage of these tax-deferred college investment plans. Let's talk a little about each:

#1: The 529 Savings Plan

It may not have the catchiest name (it's named after Section 529 of the federal tax code), but the 529 is a pretty nifty savings vehicle. It's an investment account that lets your earnings grow tax-deferred, with withdrawals for qualified college expenses also exempt from federal taxes and, in some states, from state taxes as well. Your original contributions are NOT exempt from federal income taxes, but some states allow a state income tax deduction.

These accounts are state-sponsored and every state is authorized to offer them. The maximum you can contribute per child per account, over time or in a lump sum, is determined by each state's plan. If that doesn't seem like enough (perish the thought!), you can open a second account for a child. You can even start the account before a child is born–so that you can start investing really early.

Much of the money in 529s is invested in mutual funds. As always, there are load funds and no-load funds available in most states. Go for a no-load 529 if you can in your state. Sales commissions on load funds will run as high as 4.25% — that's enough for a lot of books — and pizzas! — down the line.

Dolan Smart Money Move: Don't get taken advantage of and pay fees when you don't need to. This is a serious problem with college savings plans. A few years ago, The Wall Street Journal found that 70% of the people in Rhode Island participating in the state's college tuition savings program were buying an Alliance Capital plan through a broker and paying sales fees. The sad thing is that they could have bought an almost identical college fund directly from Alliance Capital with no load.

Why did people let this happen? Because they were more comfortable buying through a professional, which is just how the professionals want it.

Turns out that once 529s became popular because of new tax provisions in 2001, brokers launched a full-scale marketing blitz, with some of these plans being far more complicated than they need to be. Some are designed to make you scratch your head and cry out for advice from a professional.

Yet another reason we'd rather see you do it yourself with our help.

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