The average price tag for four years at a private college exceeds $170,000, according to the College Board’s Trends in College Pricing 2014. That’s 17% higher than seven years previously. In fact, rising tuition costs are outpacing inflation at the same time that federal grant aid is lagging behind inflation.

While funding four years of college can be a challenge, research also proves that higher education remains a valuable investment. According to the College Board’s Education Pays 2013, in 2011, women with bachelor’s degrees earned 70% more than women with only high school diplomas; college-educated men earned 69% more than men who graduated from high school but did not have college degrees.

There are a variety of savings vehicles and planning strategies that can help you overcome the financial challenges and reach your education goals. One tax-efficient vehicle is the Coverdell Education Savings Account (ESA), which can be used to pay for college expenses, as well as for the cost of attending qualified K-12 schools.

With a Coverdell ESA, funds have the opportunity to grow tax deferred, and withdrawals used for qualified educational expenses, such as tuition, are tax free. A beneficiary can be anyone under the age of 18 (or older, if qualified as a special needs beneficiary). Any individual (including the beneficiary) may make contributions to a Coverdell ESA, as long as his or her modified adjusted gross income for the year is less than $110,000 ($220,000 for married couples filing joint tax returns). Other features include the following:

  • Contribution limits are $2,000, per beneficiary, per year.
  • Individuals may contribute to both a Coverdell ESA and a 529 plan for the same beneficiary, without incurring any tax penalties.
  • Corporations and nonprofit groups are eligible to contribute to ESAs. Unlike individual contributors, corporations or nonprofit organizations are not subject to earning restrictions.
  • Contributions can be made up to the April tax-filing deadline.
  • It is permissible to claim either the American Opportunity Tax Credit or the Lifetime Learning Credit in the same year that you take a tax-free distribution from an ESA, provided the ESA distribution is not used for the same expenses for which the credit is claimed.
  • In addition, distributions from ESAs may be used to fund the following qualified education expenses:
  • Tuition and fees incurred by the beneficiary at any eligible educational institution, including qualified elementary and secondary schools (K-12), as well as qualified post-secondary educational institutions.
  • The cost of books, supplies, and equipment, including uniforms, computers, and related technology peripherals (if the computer-related equipment and services are to be used by the beneficiary during any of the years he or she attends school).
  • Room and board, if the beneficiary is enrolled at least half-time in an eligible educational institution. Room and board expenses are limited to one of the following: The school’s regular, posted room and board charges for students living on campus, or $2,500 for each year the student is living off campus, but not at home.

By expanding the definition of qualified educational expenses to include primary and secondary education expenses, as well as room and board, the Coverdell ESA is proving to be a welcome addition to the various tax-favored options for saving for educational expenses.

Note: Nonqualified distributions may be subject to an additional 10% federal tax penalty on earnings.