You may save taxes on the state level too by opening a college fund in the name of the child. Some U.S. states offer tax breaks for college savings accounts or tuition plans of the prepaid variety. There may be a limit, however.

These savings accounts are not for general use or even emergency funds. Premature cash withdrawals from prepaid tuition plans or 529 plans will likely be penalized by incurring a tax from the IRS (Internal Revenue Service). Tax penalties may be waived for early cash withdrawals for unusual events such as death, becoming disabled, or being a scholarship recipient.

Don't limit your college savings choices to the 529 Qualified or Prepaid Tuition Plans. The Coverdell Education Savings Account covers not only university tuition costs and any qualifying purchases needed to complete the college diploma. Coverdell plans penalize you for early withdrawals and/or unqualified purchases just as the 529 education accounts do.

Almost anyone in any U.S. state can qualify for a 529 Qualified or Prepaid Tuition Plan. Some states have a restriction that either the applicant and/or the student must live in the same state in which the financial aid account or tuition plan was obtained.

The ESA and 529 Plans may limit the total contributions that can be made to these savings accounts. Accounts in a private bank or credit union have no such restrictions on deposits to savings funds. The maximum amount you can contribute to a 529 plan might be as much as three hundred thousand dollars over the life of the account, while a Coverdell style ESA may be capped at two thousand dollars annually. There may also be limits on the amount that outsiders can contribute to these college savings accounts as gift contributions.