By Lina Martinez

There is no question that college costs have become an outrage. College costs increase at an average of 5% per year. With compounding at that rate we have ended up with a 4-year degree from a private institution averaging $134,600 and a 4-year degree from a public institution running $39,400. These costs are just tuition and fees. Add in thousands for living costs each semester, and the average college education is reaching the point where years of loan payback are to be expected. That the degree could take years to pay for itself is another story entirely.

Don’t expect a European, free college model any time soon.

Saving on taxes while putting money away for an education can help cut the costs dramatically. Starting when your child is young is even better. To that end, a 529 plan can be one of the best things that can be done to start preparing for an eventual 4-year degree cost that is increasing yearly while the average American income is decreasing or staying stagnant.

529 plans are named after section 529 of the Internal Revenue Code 26 U.S.C. There can be significant advantages to these plans such as state tax benefits, matching grants, exemption from financial aid calculations and protection from creditors.

The regular 529 plan is based on a savings model that invests the funds into mutual funds as they are added to the plan. These plans typically incorporate more risk when your child is younger and then move to more conservative funds as she gets closer to college age. The savings plans are administered by the states but usually record keeping and administrative services are delegated to financial services companies.

The big benefit is that these plans are exempt from Federal income taxes when withdrawn and used for college purposes.

A new form of 529 that is very attractive, is a prepaid plan. Currently 10 states have this plan and are accepting new applicants; Florida, Illinois, Maryland, Michigan, Nevada, Pennsylvania, Texas, Virginia, and Washington. The beauty of this plan is that tuition credits can be purchased at today’s rates to be used in the future. If you can do it, take this option for sure. The guarantee against a yearly 5% increase is so much more valuable than mutual fund investments that might not perform and have the associated management fees. Purchasing credits now for a toddler could literally save hundreds of thousands of dollars in the future.

529 plans re considered a gift and therefore subject to the gift tax. If you file separately you may contribute $14,000 per year before the gift is taxed. A couple filing jointly may contribute $28,000 per year.

The plans must be used for college costs or are subject to taxation as well. Any portion not used for college, would be taxed accordingly.

Oh, and if one of your children decides that college is not for them and that they wish to tour with their favorite band, the plans are transferable to other beneficiaries.

These plans can be one of the best ways to get ahead of the horrific appreciation in college costs. Starting earlier can provide a massive savings down the road regardless of how much you can afford to put away. Any amount makes a difference.

Contact your financial advisor or banker and ask them about plans you might start exploring today.

Lina Martinez is a contributor to zenruption’s money and life sections. She is all about helping us regular people get ahead financially and navigate the complex financial system. When we meet for drinks, we ensure that none of us mention the unfairness of the current financial system lest we get her upset.

Feature photo courtesy of Flickr, under Creative Commons Attribution-Noncommercial license