How to start an education fund for your kids

Determine how much you need to save

Yes, it's true — college is not cheap. Tuition is on the rise and will continue to escalate as your kids get older. But don't throw up your hands in despair and figure you'll just take out loans and financial aid when the time comes. Start by understanding approximately how much you need to save. The "World's Simplest College Cost Calculator" at savingforcollege.com is a good place to start.

529 college savings plans

A 529 plan is an education savings plan operated by a state or educational institution and intended to help families set aside funds for future college costs. The name comes from Section 529 of the Internal Revenue Code, which established these types of savings plans in 1996. The value of your fund fluctuates based on the market value of the investment.

The State of College Savings survey, published in August 2012, showed that 30 percent of the 800 parents surveyed are investing in a 529 college savings plan. Tax-free benefits and the cost of college were cited as key motivations. According to the College Savings Foundation, the organization that conducted the survey, parents owning 529 plans are dramatically more successful at saving than those without.

There are three types of 529 plans:

Coverdell education savings accounts (ESA)

A Coverdell ESA lets parents contribute up to $2,000 per year into an account for future education expenses. Contributions are not deductible, but the account can grow tax-free until funds are withdrawn. If the funds are used for college expenses, the distributions will not be taxed. More information on this type of savings account is available at irs.gov.

College savings with insurance

There are some college savings plans that combine savings with life insurance in a single plan. You simply save a set amount of money each month for a set amount of time, and during that timeframe, the parent receives life insurance coverage. The child can then use the funds from the plan to pay for college or pursue other dreams. This is a good option for individuals who don't like the risk of 529 plans that could lose value if the stock market goes down.

Custodial accounts

In simple terms, custodial accounts are trusts for minors. The donor designates a trustee and the name and social security number of the minor. The minor takes possession of the investment upon turning 18 or 21, depending on the type of custodial account and the state where it is held. The value of a custodial account can have an impact on a student's ability to qualify for financial aid, so make sure you understand your options if investing in a custodial account. Learn more about custodial accounts at finaid.org.

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