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FINANCIALLY SPEAKING Best Individual Taxpayer Victories of 2001 (Mar/Apr-02)
FINANCIALLY SPEAKING Overlooked Charitable Contributions (Jan/Feb-02)
FINANCIALLY SPEAKING Paperwork Mistakes That You Must Straighten Out Before Filing Your Income Taxes (Nov/Dec-01)
The Seven Deadly Sins of Running a Business (Sep/Oct-01)
Five Tools For Cutting College Tuition Costs (Jul/Aug-01)
Now That Youíve Got All The Numbers Ö What do They Mean? (May/Jun-01)
Ten Timely Tax Tips (Jan/Feb-01)
Pros and Cons of Revocable Living Trusts (Nov/Dec-00)
Thinking About Improving Your Company? (Sep/Oct-00)
Employee Benefits (Jul/Aug-00)
Have You Thought About the Future? (May/Jun-00)
Taxes (Jan/Feb-00)
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FINANCIALLY $PEAKING: Five Tools For Cutting College Tuition Costs
Paying for a childís education is increasingly expensive. Four years at an elite university may cost more than $150,000. If you have young children, the tab will be even greater by the time you receive their first tuition bill. Fortunately, the Tax Code and state law offer breaks to help you pay those bills.

Section 529 Plans

Most states now offer Section 529 plans, named after a section of the Internal Revenue Code. The plans are administered by the state, with investment decisions made by proven money managers, such as Fidelity, Merrill Lynch, Putnam, and Salomon Smith Barney. In some states the plans are run by TIAA-CREF, a low-cost money manager with an excellent reputation.

How the plan works.

  • Parents give money to the plan to cover future education expenses.
  • Income earned on this money is not currently taxed.
  • When money is withdrawn from the plan to pay for college or postgraduate expenses, your child, who probably will be in a lower tax bracket than you, will owe the tax on the deferred income.
  • You can roll over the account, tax-free and penalties free. So, if one child wins a scholarship or opts not to attend college, the account can be rolled into a younger sibling's account.
  • You can give up to $50,000 to these plans and elect to have that gift spread over five years, for gift tax purposes, so such gifts may qualify for the $10,000 annual gift tax exclusion.

Estate planning benefit: Contributing to a 529 plan is an excellent way to remove substantial assets from a taxable estate without incurring gift tax. You can get the money back, if needed, subject to a penalty. There are no income limits for making contributions, and the federal tax benefits of 529 plans are available to everyone, regardless of their income.

State incentives: Many states add their own tax benefits to these plans, such as deductible contributions or tax-free withdrawals.

Saving strategy: The earlier you start to invest for college costs, the better - because of the benefits of compounding. Thatís especially true within tax deferred 529 plans.

Federal Education Credits

Hope Credit: This per-student credit is available for the first two years of education after high school. The maximum credit is $1,500 per student, as long as you spend at least $2,000 per year for each studentís tuition and fees. EXAMPLE: Your twin daughters are college freshman when your son is a sophomore. You can claim credits for all three students, up to $4,500 per year.

Lifetime Learning Credit: This is a per-taxpayer credit. You can claim up to $1,000 of such credits per year. The Lifetime Learning Credit covers virtually any learning expense that involves acquiring new skills or improving old ones.

How It Works: You get a 20% credit on up to $5,000 of the money you spend each year.

Overall Income Limits: To get the full Hope or Lifetime Learning Credits, your income must be less than $80,000 on a joint return ($40,000 single). If your income is slightly higher you can get a partial credit.

Even if you canít claim a credit because of income limits, your child may be eligible. IRS regulations say that you can forgo a dependency exemption on your own tax return and let your child claim the credit even if you paid the expenses. High bracket taxpayers lose the benefit of dependency exceptions, in that situation, letting your child claim one of these credits may be the better choice.

Education IRAs

Nondeductible contributions to what we called "Educational IRAs" can be made on behalf of children age 18 or younger up to $500 per student beneficiary per year. Earnings are untaxed. As long as the money comes out of an education IRA for higher education costs no taxes will be due.

Problem: You canít fund an education IRA for a student in the same year that student receives contributions for a section 529 plan.

Income limits: To make the maximum $500.00 annual contribution to an education IRA, your adjusted gross income (AGI) must be below $95,000 on a single return or $150,000, filing jointly. Smaller contributions can be made up to $110,000 and $160,000 in AGI, respectively. These income limits are not really meaningful, because anyone can contribute to a childís education IRA.

Example: You earn $200,000 per year, so youíre over the limit. However, thereís nothing to stop your mother from contributing $500.00 a year to her grandchildrenís education IRAís. You can use money from a regular IRA for college too. Typically, withdrawals are subject to regular tax and 10% penalty tax if made before age 59 Ĺ. However, money that is used for higher education wonít be subject to the 10% penalty. Roth IRAs (nondeductible IRAs that may eventually provide tax free withdrawals) also can become education IRAs

Example: Your daughter starts a Roth IRA at age 13, putting $2,000 worth of baby-sitting money away each year, by the time sheís 19, and in college, she has contributed $12,000 and her account has grown to $20,000. She can withdraw up to $12,000 the amount she contributed over the years and owe no tax or penalties. The balance can remain in her Roth IRA. When she reaches age 59 Ĺ she can withdraw the earnings too tax-free.

Company Plans

If your child works, his/her employer may offer and educational assistance plan (EAP). With such a plan, the companyís contributions are deductible. Each recipient can exclude up to $5,250 per year from taxable income.

Exception: An EAP canít be used to fund postgraduate education. If you have a youngster who has been unable to get a college degree, suggest he seek a job with a company that has an EAP.

Job Related Tax Deductions

If your child is employed and the company wonít pay for college, he or she may be able to pay their own education bills and deduct the expenses that are required by an employer or to maintain professional skills. Taxpayers canít deduct expenses for schooling that qualifies them to enter a new line of business.

Deductions probably would be allowed for management courses, computer training and continuing education programs. But education that prepares someone for a new line of work wonít be deductible. The tax court has rejected write-offs for courses taken by a real estate agent that wanted to be a real estate broker, because the two jobs are significantly different. Deductions probably will not be allowed for law school, even if the graduate never practices law. But if the education qualifies, students can deduct the cost of books and lab fees as well at tuition. They also can deduct the cost of travel if they go to school from the workplace rather than from home. The money an employee spends on qualifying educational expenses is treated as a miscellaneous itemized deduction. Taxpayers can deduct such expenses only to the extent they exceed 2% of AGI.

Impact: Low-income kids probably will be able to deduct a good portions of such education expenses, especially if other miscellaneous expenses, such as tax preparation and investment outlays, are incurred.

Summary

Weigh deductions vs. the Lifetime Learning Credit. Employees who are over the 2% threshold may find that deducting these expenses at; say 28% is a better deal than taking a 20% credit. But those who arenít over the threshold may be able to take the credit.

For more information, click on the Author Biography link at the top of this page.

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