Save for college in tax-advantaged accounts.

For the 2004 through 2005 period, the average cost of attending a 4-year private college is $20,082--up 6 percent. The cost of a 4-year public college is $5,132--up 10.5 percent. The tax laws provide certain tax-advantaged savings methods to encourage saving for college. Although contributions to all of these plans are not deductible for federal income tax purposes, the funds build up on a tax-deferred basis, and earnings are never taxed if distributions are used for tuition and other eligible expenses.

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529 Savings Plans

All states have college savings plans, and contribution limits and investment options are set by each state. The amount of money available at the time the child is in college depends on the plan's investment performance. Investment losses from 529 savings plans can be claimed only if all funds are withdrawn and they are less than the total contributions.

Although anyone can make contributions to 529 plans, donors are not limited to the plan in their state or the beneficiary's state; they can choose any plan open to nonresidents (most plans are open plans). States may provide tax incentives for contributions within their state.

These contributions are eligible for the annual gift tax exclusion ($11,000 in 2005; $22,000 if a spouse participates). Amounts in excess of the annual gift tax exclusion are treated as having been made over five years (i.e., eligible for five annual exclusions). For example, a grandparent can contribute $55,000 per grandchild in 2005, and the gift is fully shielded by the gift tax exclusion. Wealthy grandparents who are planning to help pay for a grandchild's education can effectively pre-fund this expense now with 529 plan contributions that immediately remove assets from their estate.

Section 529 savings plans allow contributions to grow on a tax-deferred basis and provide for tax-free withdrawals as long as withdrawn amounts are used for qualified higher education costs. Assets invested in 529 plans are explicitly protected by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. Funds contributed to this type of plan more than one year prior to bankruptcy are excluded from the bankruptcy estate if the beneficiary of the plan is a child, stepchild, grandchild or step-grandchild of the debtor. However, contributions made between one and two years prior to bankruptcy are protected only to the extent of $5,000 per beneficiary. For more information on 529 plans, visit www.savingforcollege.com.

529 Prepaid Tuition Plans

In contrast to savings-type plans in which funds can be used for tuition, room and board and other qualified expenses, prepaid tuition plan funds can be used only for tuition. However, contributions buy a guaranteed portion of tuition, even if tuition increases. Contributors avoid the risk of investment losses associated with other college savings plans.

State plans. Less than half the states currently offer prepaid tuition plans providing guaranteed tuition at state universities and colleges. If the child does not attend a state school, a refund generally is limited to contributions (plus, in some cases, a very modest investment return).

Private plans. Private schools offer prepaid tuition plans but not savings plans. More than 250 schools, including many prestigious ones, have joined the Independent 529 Plan, a nonprofit private prepaid tuition plan managed by the Teachers Insurance and Annuity Association--College Retirement Equities Fund (TIAA-CREF).

Like state prepaid tuition plans, contributors lock into a portion of the tuition. For example, say a parent expects his child to attend his alma mater (a participant of the Independent 529 Plan). If current tuition is $26,000 a year, the parent can lock into 50 percent of a year's tuition by paying $13,000 now. Regardless of intervening increases, half of a year's tuition is guaranteed. Of course, there is no guarantee the child will be admitted to the school. Participating schools have different discount formulas (contributors effectively obtain tuition discounts). For more information and a free CD-ROM, contact www.independent529plan.org. Indicate whether you desire a CD-ROM from a financial advisor perspective or consumer perspective.

Coverdell ESAs

Annual contributions to Coverdell Education Savings Accounts (ESAs, formerly called education IRAs) are limited to $2,000 per year per beneficiary. However, high tax-bracket individuals are ineligible to make these contributions; the adjusted gross income ceiling on joint filer contributors is $190,000 to $220,000. This phase-out range is double that for singles.

Coverdell ESAs offer the widest range of eligible expenses for which withdrawals can be made tax free, and they include not only the cost of higher education, but also elementary and secondary school--including private and religious day schools. They also include the cost of a computer and Internet access fees, school uniforms, transportation costs and after-school activities.

Like 529 savings plans, Coverdell ESA funds available for the beneficiary's education depend solely on investment performance. Unlike savings plans, however, ESA contributors retain full investment control. Savvy investors may be able to accumulate more on these funds than on funds contributed to a state 529 savings plan.

Mr. Kess has authored 25 books on tax-related topics. He probably is best known for lecturing to more than 45 state societies and more than 700,000 practitioners on tax and estate planning. He created and moderates the annual AICPA Conference on Tax Strategies for the High-Income Individual. A graduate of Harvard Law School, Mr. Kess received his LL.M. from New York University.