Smart New Ways to Save for College

The Coverdell ESA plan, previously known as the Education IRA, was redesigned to give parents another option for educational savings, including elementary and secondary schools. Coverdell ESAs are similar to a Roth IRA but are geared specifically to education costs. They can be used in combination with the 529 plan or prepaid college plan, but currently $2,000 is the maximum annual savings that can be contributed.

Though these accounts provide similar tax-free benefits, they are not as flexible as 529 plans due to the low contribution limit and because law prohibits ESA funding once the beneficiary reaches age 18 (the money will be subject to tax penalties if not fully withdrawn before the student turns 30).

Another disadvantage is the contribution has to be distributed to your child even if it is not used for college—and you cannot refund the account back to yourself as you can with most 529 plans. Withdrawals may be fully tax free but limited by taking other tax deductions such as the Hope or Lifetime Learning credit. Similar to the 529 plans, tax advantages will expire in 2010 unless voted otherwise in Congress.