Tax Free Savings Accounts

The federal government gives tax breaks to families or individuals that save money for the higher education costs of their children or other designated beneficiaries. The Coverdell Education Savings Account (ESA), formerly known as an Education IRA, is an investment trust account specifically designated for qualified education costs, which include both K-12 expenses and higher education expenses such as tuition and fees, books, and room and board for students enrolled at least part-time. Money deposited and interest earned on that money are not taxed, and withdrawals for education expenses are tax-free. Only individuals with income below $110,000 ($220,000 for joint filers) can contribute to a Coverdell ESA, and annual contributions are limited to a total of $2,000 per beneficiary. In aggregate, the policy will lower taxes for participants by $80 million in 2013.

Qualified tuition programs, also known as "529 plans," are savings plans established by states and institutions of higher education. A 529 plan allows families or individuals to prepay for a student’s qualified education expenses—tuition and fees, books, and room and board for students enrolled at least part-time—or contribute to a tax-free account specifically designated for these higher education expenses. Institutions can only sponsor prepaid plans. An estimated $2.02 billion in federal tax reductions will be provided through the benefit in 2013.

There are two types of savings plans: direct and state-administered/broker-administered. The federal tax benefits for 529 plans include tax-free earnings and distributions. There are no income restrictions for contributors under the federal benefits, and each contributor can add up to $60,000 in tax-free funds over a five-year period per beneficiary. States offer a range of additional benefits, including tax deductions, tax-free earnings, and tax-free withdrawals. Some states also offer matching grants to low-income families who contribute to state plans. Contribution limits vary by state, but in general are limited to between $200,000 and $300,000 in tax-free savings.