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College Tuition Costs Now Rival A Bentley
There’s one key chapter missing from What to Expect When You’re Expecting, and it plays to the tune of $175,000: the cost of your child’s college tuition. Whether you are a young parent eagerly welcoming a new bundle of joy to the world or if your little bundle has just set foot into fifth grade, you need to know your options. Yes, education is expensive. But smart, strategic steps can set you up for long-term success. Sure, there are opportunities in the different forms of College Savings Plans, Student Loans, and Tax Credits. The trick is figuring out what is right for you and your future scholar.
College savings plans
College savings plans generally take three different forms: Section 529 Plans, Coverdell education savings accounts and Education Savings Bond Program. Each of these plans provide tax benefits that can make a big impact on your bottom line. The key difference among them is in contribution limits and spending rules.
When you contribute to a 529 Plan, your investment earnings grow tax-free, meaning that the later tuition payment from the plan won’t be touched by Uncle Sam. There is generally no limit to how much you can contribute to Section 529 plans, good news for families in upper income brackets. In some instances, contributions are also deductible for State income tax. However, Section 529 Plans are sponsored and administered by states, meaning that you will have less flexibility and choice regarding investment options. The 529 Plans do differ from state to state, so be sure to visit www.collegesavings.org to understand your state’s policies.
Coverdell education savings accounts, also known as ESAs, offer the same benefit of tax-free earnings. They differ from Section 529 Plans by their $2,000 a year contribution limit, and an inability for families who earn $220,000 or more to contribute. Once your child turns 18, you can no longer contribute to the Coverdell plan, and if there are still funds remaining when your child turns 30, there will be tax penalties. An interesting perk of a Coverdell plan is that it is eligible for K-12 education expenses as well, a nice benefit for parents eyeing private elementary schools.
Education Savings Bond Programs allow parents to save for their child’s education by investing in government bonds. The programs allow for contributions up to $10,000 per year and interest earned on the bonds is not taxed for qualifying parents. Unfortunately, the modified adjusted gross income (MAGI) phaseouts begin at $77,550 ($116,300 if married).
As with any loan, the “buy now, pay later” mantra applies, with interest typically at a small, forgivable rate. A key difference to understand in a student loan is whether it is “subsidized” or not. Unsubsidized loans accrue interest once it is used, and the subsidized alternative do not accrue interest until after the student is done with school. And most loans begin repayment after the six-month grace period.
Interest rates differ rather significantly between these loans. Loans can be found from both government entities and financial service companies (i.e. banks, credit unions). Because interest rates are always changing, an analysis of available rates at the time a loan is taken is key to any decision.
Education Tax Credits
Broken down into two different credits—the American Opportunity Credit and the Lifetime Learning Credit—these take the form of tax write-offs for those seeking postsecondary education or improving job skills. The important aspects of these to keep in mind is if you qualify.
For the American Opportunity Credit, if individuals earn less than $90,000 ($180,000 for joint households), then the tax credit can be used up to a maximum of $2,500 per eligible student per year\. On the other side of the tax credit coin, The Lifetime Learning Credit applies to those earning less than $65,000 per year ($131,000 for joint households). With this credit, 20% of qualified expenses up to $10,000 allows for a maximum credit of $2,000 per tax return.
Education tax credits when paired with eligible education deductions can make for a mighty couple. Those who qualify (MAGI less than $80,000/$160,000) may be permitted to deduct up to $2,500 from their annual tax returns for qualified student loan interest. Also available are tuition and fees deduction, up to $4,000. Keep in mind that these deductions are at the mercy of our lawmakers, and with the ever-changing mindscape of our Congress, deductions that are here today are not promised to be here tomorrow.