As the need for a college degree has increased, the cost of going to college has also increased.  According to the College Board, for the 2011 – 2012 academic year, the average annual in-state tuition and fees at a public four-year college is $8,244, and the average out-of-state tuition and fees is $20,770.  The average annual tuition and fees at a private nonprofit college is $28,500.  These costs do not include room and board, books or supplies.  Because of this, parents should seriously consider saving towards these costs while their children are young.  Parents may choose from an array of tax-favored savings options.  These options include Coverdell Education Savings Accounts, Section 529 plans, and savings bonds.  No single option works best for everyone, but by reviewing the options available families can choose what best meets their needs.  Hopefully, some of these options will make paying those bills a little easier.  Here is a rundown of what is available.

Coverdell Education Savings Accounts (CESAs)

CESAs are nice savings accounts.  You can make annual contributions of up to $2,000 for each child until the college-bound child turns 18.  The earnings in these accounts build up tax-free and the money can be withdrawn (also tax-free) to pay for qualified college expenses.  CESA contributions are nondeductible, but the tax-free withdrawal privilege makes up for that.  If the beneficiary of the account doesn’t attend college or they don’t incur enough expenses to exhaust their entire account, the balance can be rolled over tax-free into another family member’s CESA.  You have until April 15th of the following year to make your CESA contributions for the tax year in question and the ability to make contributions begins to phase out once your AGI is over $190,000 on a joint return and $95,000 for singles.  If the income limitation is a problem, the child can make a contribution to their own account.

Qualified Tuition Programs (Section 529 Plans)

Qualified tuition programs allow you to buy tuition credits for a child or make contributions to an account that is set up to meet a child’s future higher education expenses.  These programs can be established by state governments or by private education institutions.  Contributions to these programs aren’t deductible for federal income tax purposes, but some in-state programs may offer state tax advantages.  The contributions are treated as a gift or completed gift, but are eligible for the annual gift tax exclusion ($13,000 for 2012).  A donor who contributes more than the annual exclusion limit for the year can elect to treat the gifts as if they were spread over a five year period.  This means a married couple may make a lump-sum payment of up to $130,000 (5 x $13,000 x 2 = $130,000) without any adverse gift tax consequences.  College savings account plans are a great deal since earnings on the contributions accumulate tax-free until the college costs are paid from the funds. Distributions from qualified tuition programs are tax-free to the extent that the funds are used to pay qualified college costs to attend any accredited college or university in the country.  Distributions of earnings that are not used for qualified higher education expenses are subject to income tax plus a 10% penalty.  Contributions to these programs are not subject AGI limitations.

Series EE U.S. Savings Bonds

Series EE U.S. savings bonds offer two tax-savings opportunities when used to finance your child’s college expenses.  First, the interest on the bonds is not reported for federal tax purposes until the bonds are actually cashed in; and second, interest on qualified Series EE (and Series I) bonds may be exempt from federal tax if the bond proceeds are used for qualified college expenses.  To qualify for the tax exemption for college use, the bonds must be purchased in the parents name not the child’s.  If your AGI exceeds certain amounts, the exemption is phased out.  For bonds cashed in during 2012, the exemption begins to phase out for joint filers at $109,250 and $72,850 for singles.

 Tax-exempt Bonds

Another way to achieve economic growth while avoiding tax is tax-exempt bonds or bond funds. Interest rates and risk vary, so take care in selecting your  investment. Some tax-exempt bonds are sold at a deep discount face value and don’t carry interest coupons. A small investment in these so-called zero coupon bonds can grow into a fairly sizable fund by the time your child reaches college age. “Stripped” municipal bonds (munis) provide similar advantages.

Planning should start when children are young. Contact a qualified professiona. There is no better time than now to start planning for your children’s higher education.