Some ways of investing for college come with federal income tax breaks and sometimes state income tax breaks as well, in the form of tax-free earnings on your investment. In some states you can also take a tax deduction for contributions you make to certain plans.
There are some restrictions
with each of these opportunities. In some cases, income
caps limit who can contribute. Some plans impose penalties
for changing your mind about how you use the assets.
In some cases, the assets must be used before the beneficiary
turns 30. And you must be sure, if you’re withdrawing
from more than one account in the same year, that you
use the money to pay different qualifying expenses.
But while you need to be aware of these rules and comply
with the ones that affect you, they’re likely to
play only a minor part — or no part at all — in
choosing one or more of the plans as the primary way
you invest.
So what's qualified?
The one big restriction that’s attached to tax-free plans is that any earnings must be used to pay qualified education expenses. The trick is that each plan defines qualified expenses slightly differently. Tuition, fees, books, and supplies almost always count. In some plans, room and board qualifies, but in others it doesn’t.
