Many people become concerned when it comes time to send a child to college. Students can fill out the Free Application for Federal Student Aid (FAFSA®) to apply for student aid, but it may not be enough. They may even be turned down for student aid. In either case, they may not be able to go to higher education without some help. But there are tax provisions you can utilize to cover the gaps in financing.
The 529 Plan
This tax-deferred investment is similar to a mutual fund, where funds are invested in stocks and bonds for a better return. Withdrawals for college expenses are tax-free. You can use the money for any college or university in any state, and for more than one child. Some plans also offer automatic withdrawals from your checking or savings account so building the account is easy. Unlike prepaid tuition plans, you can save as much money as you want per year.
The other side of these plans is that if for whatever reason you want to use the money for anything else besides college expenses, you’ll pay a 10% penalty as well as state and federal taxes according to your current income tax bracket. That means if your child doesn’t go to college, you won’t be able to re-invest it without penalty. But you can transfer the money to a different family member.
Tax Credits
There are two notable tax credits that you should be aware of if you are sending a student off to college:
- American Opportunity Tax Credit (AOTC)—this credit provides a maximum annual amount of $2500 per student in the first four years of undergraduate education. This consists of:
- 100% of the first $2,000 of qualifying expenses
- 25% of the next $2,000 of qualifying expenses
Up to $1,000 could be refunded if it reduces the taxpayer’s liability to zero. In order to claim this credit, the taxpayers’ Modified Adjusted Gross Income (MAGI) must be below $80,000 if single and $160,000 for married couples filing jointly.
- Lifetime Learning Credit (LLC)–this credit provides a maximum annual amount of up to $2,000 per tax return from the first $10,000 of qualified expenses. Unlike the AOTC, it is not refundable. You can only claim it once per return, but you can claim it every year. You can can claim up to the maximum of $10,000 in total expenses for all eligible students, equal to 20% of the expenses. The income limits for the LLC are $55,000 for a single taxpayer and $160,000 for married filing joint taxpayers.
You can learn more about these tax credits at the IRS website.
Student Loan Interest Deductions
You can deduct up to $2,500 paid in a tax year up to specific MAGI thresholds.
The loan must have been taken specifically for educational expenses for the taxpayer, a spouse, or a person who was a dependent at the time the loan was taken out. The loan may not be from a relative or an employer’s plan, and the student must have been enrolled at least half-time at an eligible educational institution. The enrolled program would lead to a degree, certificate or other recognized educational credential. The loan can be used for tuition, fees, books, equipment and supplies, as well as room and board.
The 2018 threshold for single taxpayers is $65,000, and completely phases out at $80,000. For married taxpayers, the threshold is $135,000 and phases out at $165,000.
Educational Trusts
This is another option for setting aside money for higher education in the future. In the process, you’ll lower your own tax liability and ensure that the money needed for college will be available for the beneficiary. Read more about how James Provenza can work with you to set up an educational trust that suits your needs.
Make Higher Education Easier
If you’re wondering how to send your children, grandchildren, your spouse, or even yourself to college, there are ways to make it more affordable with a wide range of trusts and other available options.
James C. Provenza is an Illinois estate planning attorney with years of experience helping clients with their estate planning to make sure their wishes are carried out. Call our firm today at (847) 729-3939, or use our online contact form.
