If you have a child or children that are college-bound, you may be stressing over the future funding of tuition and other higher education costs. You will want to take maximum advantage of tax benefits to minimize your expenses. Here are 3 possible options that may help you in doing so.
1. Savings bonds
Series EE U.S. savings bonds offer two tax-saving opportunities for eligible families when used to fund higher education costs:
- The interest on the bonds is not reported until the bonds are cashed out for federal tax purposes, and
- If the proceeds from the bond are used for qualified education costs, the interest may be exempt from federal tax purposes.
In order to be eligible for the exemption, the bonds must be purchased in the purchaser’s name, not the student’s name. Earnings must be used to pay for tuition and other higher education fees (note: housing and meal costs can’t be reimbursed). Only the portion that is used for qualified education expenses is exempt.
The exemption is phased out once your adjusted gross income (AGI) exceeds certain amounts.
2. 529 plans
The 529 plan is a tuition program that allows for the purchase of education credits and the ability to make contributions to an account set up for a child’s higher education expenses.
Funds contributed to these accounts are not deductible. The earnings on these contributions accumulate tax-free until college costs are paid from the funds. Distributions from 529 plans are tax-free to the extent the funds are used to pay “qualified higher education expenses.” Distributions of earnings that are not used for college expenses will be subject to income tax plus a 10% penalty tax.
Most states also offer state-sponsored 529 plans. The benefit of state 529 plans often includes a state income tax deduction for the annual contribution. For example, for 2021 in Wisconsin, Edvest allows a state tax deduction of up to $3,380 per year per beneficiary account.
3. Coverdell education savings accounts (ESAs)
Coverdell ESA is an account that one can contribute up to $2000 annually for each child under the age of 18. Once your AGI is over a certain amount you no longer have the ability to make contributions. Planning idea: a child has the ability to fund his or her own account.
Similar to 529 plans, the contributions for this account are not deductible, income will not be taxed, and distributions are tax-free when used for qualified education fees. If the child doesn’t attend college, the money must be withdrawn when he or she turns 30, and any earnings will be subject to tax and penalty. If the child does attend college the unused funds can be transferred tax-free to a Coverdell ESA of another member of the child’s family who hasn’t reached age 30. (Some ESA requirements don’t apply to individuals with special needs.)
Plan now to save for college
These are just some of the tax-favored ways to build up a college fund for your children. Once your child is in college, you may also qualify for additional tax breaks such as the American Opportunity Tax Credit or the Lifetime Learning Credit. Contact your Wegner CPAs tax advisor to discuss any of these options.