Education Savings

Uncle Sam Wants to Help You Pay Your Education Expenses

By Dr. John L. Stancil
Tax Analyst, WebTaxCenter.com

Congratulations! You have just become a new parent (or grandparent). Naturally, you want to provide the best for your new descendent, including giving the youngster the best education possible. You know that a college education is expensive, and becoming more so. So your first inclination is to make sure he or she excels in athletics and can earn a full scholarship to the school of his or her choice. Then reality sets in. You realize that if your child's athletic prowess is inherited from you or your spouse, an athletic scholarship is about as likely as getting struck by lightning - twice.

In talking with friends and co-workers they tell you of various programs the Federal government offers to help you save for your child's education. But you have heard so many things that now you are totally confused. Besides, you really have trouble understanding all this tax "mumbo-jumbo."

Basically, there are two types of programs that will help you meet education costs - savings programs and tax incentives. Both of them have their place in the kaleidoscope of financing your child's education.

Savings Programs

Since you need to get started yesterday on the savings programs, we will look at those first. Basically, there are four opportunities here - Coverdell Education Savings Accounts, 529 Plans, withdrawals from an IRA, and interest exclusion from U. S. savings bonds.

Coverdell Education Savings Accounts.

A Coverdell Education Savings Account (CESA) will allow you to contribute up to $2,000 a year for each child until the child reaches age 18. You do not get a tax deduction for contributions to a CESA, but all withdrawals including earnings are tax-free when used for qualified education expenses. Unlike other programs, CESA funds may be spent to cover the cost of room and board. These can also be used to pay expenses for elementary and secondary education.

When used for elementary and secondary education expenses, much of the tax benefit is lost, as the funds will not be in the account long enough to accumulate a large amount of earnings. Another drawback of the CESA's is that you can only contribute a maximum of $36,000 for each student. Some earnings will be achieved, but these accounts simply are not structured to accumulate big bucks.

IRA Withdrawals

Your IRA can serve as a useful tool for financing higher education expenses. Unlimited withdrawals may be made from a traditional or Roth IRA without having to pay the 10% penalty if the funds are used for qualified higher education expenses, but income tax will probably be due on at least a part of the withdrawal. You can use the money to pay education expenses for you , your spouse, children, or grandchildren. This can be quite useful, as you can accumulate a significant amount of dollars in the IRA. However, tapping into it may have an adverse effect on your retirement income.

Series EE Savings Bonds

Another tax break for education involves U. S. Series EE Savings Bonds. The interest earned on these bonds may be excluded from tax if the proceeds were used to pay qualified higher education expenses. You can pay expenses for you, your spouse, or dependents. However the bonds must be in your name.

529 Plans

Probably the best approach to planning for college expenses is a 529 plan. These are also known as Qualified Tuition Programs. There are two types of these plans - savings plans or prepaid plans. Each state offers at least one 529 plan, but you do not have to live in the state to participate in their plan, nor do you have to attend school in that state. 529 plans have four distinct advantages.

First, although contributions to the plan are not tax deductible, the growth from the investment is tax free and withdrawals are not taxed when spent for qualified education expenses.

Second, as a donor you control the account. You can set up a plan for anyone, but the intended recipient of the funds has no access to the account. It is up to you when the withdrawals take place, how much is withdrawn, and what is done with the proceeds.

Third, you can fund it as you choose. This can be irregular deposits or regularly scheduled, automatic deposits.

Fourth, everyone is eligible to take advantage of a 529 plan. There are no income limitations. In addition, the plan can be funded rather substantially.

Tax Incentives

"Ok," you say. "All of these sound great, but what if it is too late to accumulate significant funds for college. My kids are in high school." There are a couple of tax breaks for you. The Hope Scholarship and Lifetime Learning Credits can save a substantial amount on your taxes come April 15.

Hope Scholarship Credit

The Hope Scholarship credit is available for two years only per student. It is a credit of 100% of the first $1,100 of qualified education expenses and 50% of the next $1,100 for a maximum credit of $1,650 per student. The student must be pursuing a degree, enrolled at least half time in a qualified educational institution and have no felony drug convictions.

Lifetime Learning Credit

The Lifetime Learning Credit is 20% of the first $10,000 in qualified education expenses for a maximum of $2,000 per return. This credit can be used during all years of postsecondary education and for courses to acquire or improve job skills. There is no limit on the number of years this credit may be taken. The student is not required to be pursuing a degree and can be enrolled in as little as one course.

If the student is enrolled in an eligible educational institution in the Louisiana, Mississippi, or Alabama (Gulf Opportunity Zone) the amount of these credits is doubled. Note that these are credits, and not deductions. Credits are a direct reduction of your taxes.

Student Loan Interest

Finally, if all else fails and you have to take out a loan, the interest on qualified student loan is deductible even if you do not itemize your deductions. You can deduct up to $2,500 in interest and the student must have been enrolled at least half time in a degree program.

There are a number of "qualifiers" for these programs and you should consult your tax advisor before pursuing one of them. Additional information is also available on the web at sites such as www.irs.gov and www.webtaxcenter.com.

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Dr. John L. Stancil, a tax analyst for WebTaxCenter.com, has been a member of the Florida Southern College faculty since 1998. He received his bachelors degree from Mars Hill College and holds a M.B.A. from the University of Georgia. He later earned his doctorate in accounting from the University of Memphis. He holds four professional certifications, including CPA, CMA, CFM and CIA. Stancil has received the Florida Institute of CPAs 2005 Outstanding CPA in Public Service Award. (This award is given annually to a Florida CPA who has demonstrated significant contributions through community and civic activities.) He has also been recognized as the Expert of the Month on several occasions by allexperts.com.

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