Different saving plans

What are the different savings programs? Let’s look at the most widely used types of special college savings plans:

Coverdell education savings accounts: The plans let anyone, including your parents, put away up to a total of $2,000 a year for you in a special type of investment account that grows tax free. You and your parents decide how to invest the money in a Coverdell account — in fact, it’s up to you, perhaps working with an investment professional at your bank or other institution, to figure out the best way to make the money grow. Then, when you’re ready to go to college, you can start using the money for educational expenses. But you must use it before you turn 30.

But there are a few catches. For one, your parents can’t contribute to a Coverdell if they earn more than $220,000 a year (or $110,000 if your parent files taxes as a single taxpayer).

Because only $2,000 or less can be invested in a Coverdell each year, these plans usually work best if your parents have been contributing for a number of years. And that’s why if you already have a baby of your own, it may be smart to set up a Coverdell account now. The money will have almost 20 years to grow, depending on how you invest it and add to it along the way.

529 plans: States offer college savings programs called “529 plans.” The name comes from a certain section of the IRS tax code. These are basically investment accounts set up by the state, although you don’t have to participate in the one offered by the state where you live. Rather, you can shop around for the plan that you and your parents think offers the best investment returns.

Unlike with a Coverdell, you and your parents don’t have to make all the decisions about how the money is invested. Instead, a professional money manager runs each state’s individual plan, and he or she decides how to invest the money. Usually all you have to do is choose among age-based or risk-based investment alternatives. It’s important to remember, though, that there’s no guarantee that the money will grow at any particular rate in either type of account and that even if you save regularly you may not have as much as you need when you’re ready to enroll.

And there’s another catch. The money in a 529 plan must be used for higher education — not for that trip to Cancun with your friends — or you’ll have to pay the tax that’s due on the accumulated earnings plus potential penalties.

Because states have different fees, rules, and criteria, you’ll want to shop around for the 529 plan that’s right for you. Also, like Coverdell assets, 529 plan assets must be included on your FAFSA, in your parents’ name.

Prepaid tuition plans: Some states and a group of private colleges offer prepaid tuition plans. Basically, you pay for tuition credits at today’s rates and the plan typically promises that what you’ve paid will cover the same number of tuition credits when you enroll. The state that’s running an individual program wants you to use the money to attend college in that state. The same is true of the group of private colleges. But you have some flexibility. If you decide to go somewhere else in the end, the money can usually be applied toward expenses at another school — although you may simply get back the amount you put into the plan. You’re smart to check first. The money in these accounts goes under your parents’ name on your FAFSA.