A Tax Fact from The Tax Institute at H&R Block

If you're waiting to start saving for your child's education - don't.

Besides the fact that it's never too early to begin stashing away money for a college education, the here-and-now is a great time to take hold of some of the tax benefits that can go along with your saving efforts.

Two of the most tax-savvy ways to save for your kid's future can be found in Coverdell Education Savings Accounts, or ESAs, and Qualified Tuition Plans, known as QTPs.

The main attraction for these programs is the same that draws you to your qualifying retirement account: distributions from ESAs and QTPs are tax-free when withdrawn and used for your child's education. That’s right, tax-free.

There are several rules related to ESAs and QTPs that translate into both increased savings and more options:

• The contribution limit for Coverdell ESAs is $2,000 a year. You can contribute even more – often much more – to QTPs.
• You can contribute to both an ESA and a QTP within the same year's time.
• QTPs offer many investment choices, and if you aren't crazy about the fund you're in, you can roll the funds into a different fund once in any 12-month period.
• Private and religious institutions can establish QTPs, expanding your choices of prepaid tuition plans.

There isn't one way of saving that is, hands down, better than the other. As a rule, education savings should be invested - you'll earn a better return when compared to the fairly low interest rates offered by bank savings accounts. But the "right" investment mix depends on the length of time until the beneficiary goes to college.

The pre-tax earnings and non-taxable distributions offered by QTPs and ESAs can make a difference. And, many states offer a deduction or credit for residents who contribute to that state's QTP. (For more information on QTPs, visit http://www.savingforcollege.com.)

If you're planning to apply for need-based loans, grants, or scholarships, "how" you save can be just as important as “how much” you save. You should be aware that distributions from prepaid tuition plans, offered in QTPs, may count as the student's income, which may reduce or eliminate financial aid. The same goes for ESAs. They may also count as the student's assets on financial aid applications. 

The right choice for you might actually be a combination of two (or more) of the available savings methods. You should investigate the options (and the financial aid consequences), and choose the method(s) that will help you reach your savings goal for your child's education. The best advice is to talk to your tax and financial advisor. And, remember, those college days will be here before you know it.

This Tax Fact is brought to you by The Tax Institute at H&R Block.

To view other helpful tax information or listen to our Tax Fact podcasts, visit www.digits.hrblock.com

As always . . . everyone’s tax situation is different, so be sure to consult a tax professional or financial advisor before making important financial decisions.

This Tax Fact is for educational purposes only and is not intended to be a substitute for seeking personalized, professional advice, nor is it intended to be used to avoid IRS penalties.