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In addition, you can find ways to pay that don’t involve your checkbook, like federal tax credits, scholarships, and student loans.

Sure, tuition costs can be overwhelming. But the worst thing to do is nothing at all.

You don't have to win the lottery to send your child to college.

The earlier you start to save for college, the greater your accumulated funds can be. If you begin a college savings account for a child at birth, you’ll have up to 18 years to take advantage of long-term growth potential. That’s why investing regularly can be so rewarding; even if you invest just a small amount every month, your money can grow into a considerable sum over time.

In general, the number of years before college is your best indicator of the types of investments to make. When your children are young, you might consider investing in stocks or stock mutual funds because you’ll have many years to ride out possible market volatility. As your children grow older, you can gradually shift to more stable investments such as bonds, bond mutual funds, certificates of deposit (CDs), and money market accounts. You should plan your investments in bonds and CDs to mature as your first tuition bills come due.

In past years, certain states introduced prepaid tuition plans that, although attractive in their own right, locked you in to attending a state school. Today, most states have introduced the next generation of college savings plans: 529 plans, also called qualified tuition programs. There are two types of 529 plans: prepaid tuition plans and education savings plans. Prepaid tuition plans permit a donor to purchase tuition credits whereas education savings account plans permit a donor to make contributions to an account held for the benefit of a designated beneficiary. If a state offers an education saving account plan, the state selects a financial institution that will manage the accounts. Your investment choices are therefore limited to those selected by the state. However, you may transfer credits or amounts from one 529 plan to another 529 plan or from portfolio to portfolio once a year with no tax consequences as long as the beneficiary remains the same. You may also change beneficiaries as long as the new beneficiary is a member of the first beneficiary’s family. Under the 2001 tax legislation, private educational institutions will also be able to offer prepaid tuition plans but not the education savings account plans.

Although each 529 plan is different, they offer generous tax advantages plus high contribution limits. Any individual (parent, grandparent, aunt, uncle, generous neighbor) may contribute up to $10,000 ($20,000 for married couples) in a single year to a 529 plan without paying gift taxes at all. Each contributor may contribute up to $50,000 ($100,000 for married couples) in a single year without paying federal gift tax, as long as no additional contributions are made for five years. The IRS considers contributions to a 529 plan “completed gifts”. So the money is excluded from the contributor’s estate. This is true even if you or another individual retains control of the plan.

Generally, you can open a 529 plan for any person regardless of the beneficiary’s age or your income level. The assets remain under your control, and you can usually contribute as little as $25 a month or as much as you like, up to the plan’s contribution limits. A 529 plan is considered an asset of the account owner for purposes of financial aid eligibility. Since most colleges expect parent to contribute only a small percentage (currently about 6%)* of their assets each year for education funding, the 529 plan will fall into the 6% bracket, which means your child may be more eligible for financial aid. If the 529 plan is held in a name other than a parent or the child (remember those relatives and generous neighbors mentioned earlier?), it will stay out of the financial aid formula altogether.
*As of October 2001.

Beginning in 2002, withdrawals from 529 plans are tax-free if they are used for qualified educational expenses, which include tuition, books, fees, room and board, and equipment required for enrollment at an eligible educational institution. Certain states allow their residents to make either tax-deductible contributions or take tax-exempt withdrawals.

As with most investment, there is no guarantee of specific returns. Participation alone does not ensure that your contributions and earnings will be adequate to cover your child’s college expenses. If you decide to withdraw funds for any other reason than education expenses, you will pay federal and state income taxes and a 10% federal penalty on all gains. Exceptions include if the beneficiary receives a scholarship, becomes disabled, or dies. However, because of their flexibility and favorable tax treatment, 529 plans can be an excellent choice for educational savings.