Saving for College Plans

Posted on February 15th, 2010 in Educational Expenses, Newsletter Articles, Taxes by wayne

It is expected that taxes will soon rise.  It is also fairly certain that the cost of a college education for our children or grandchildren will continue to rise faster than the annual rate of inflation.  Let’s look at some of the ways that you can save taxes while saving for your children’s or grandchildren’s college education.

You may be aware of the Qualified State Tuition Program, commonly called a Section 529 College Savings Plan.  With the 529 College Savings Plan you can provide a fund for each child.  Contributions are treated as gifts to the person for whom the plan is established and receive the annual gift tax exclusion of $13,000.  A couple may double this gift amount to $26,000.  A unique attribute of the 529 College Savings Plan is the ability to provide up to five times the annual federal gift tax exclusion amount in a single year.  This allows a single gift of up to $130,000 for each child.

529 College Savings Plan contributions are not tax deductible.  However, all interest and appreciation of the plan’s assets grow tax free until withdrawn.   As long as funds are withdrawn to pay for qualified higher education expenses, the withdrawals are also tax free.  If a designated beneficiary does not use their 529 funds, the donor you may change the beneficiary to a different person, including themselves.  However, if withdrawn funds are not used for higher education expenses, a ten percent penalty plus taxes on all of the funds growth and income will be applied to the withdrawal.

The Coverdell Education Savings Account (ESA) is a less know college savings plan.  Tax-wise, the Coverdell ESA behaves the same as a 529 plan.  However, Coverdell ESAs allow only a $2,000 annual contribution for each beneficiary.  On the positive side, a Coverdell ESA can be set up similar to a Roth IRA providing the “responsible party” with virtually unlimited investment options.  As long as the beneficiary has not reached age 30, the “responsible party” for the Coverdell ESA may change the beneficiary to another person under age 30.

When you purchase EE and I Savings Bonds, they may be redeemed tax free when the bond owner, their spouse or other dependents use these funds to pay for college tuition and fees.  However, due to income phase outs restrictions, full deductibility is lost when a couple has taxable earning above $104,900.

You may also withdraw funds from an individual retirement account, before age of 59 ½, to pay for any family member’s qualified post-secondary education expenses.  The proceeds will be treated as a normal IRA withdrawal with the 10% early withdrawal penalty waived.  .

The Hope Scholarship Credit, now called the American Opportunity Tax Credit (AOC), allows a parent to claim up to a $2,500 annual tax credit for a dependent’s college tuition and mandatory fees.  This tax credit will “phase out” for couples earning above $160,000 per year.  Since this is a tax credit, the full amount (up to $2,500) can be deducted from taxes owed.

The Lifetime Learning Credit can help pay for your own, your spouse, or your children’s education.  You may claim a tax credit of twenty percent of up to $10,000 in combined tuition and mandatory fees for anyone (and everyone) in your family.  Like the AOC, the Lifetime Learning Credit is a tax credit, lowering taxes owed up to $2,000.

The Lifetime Learning Credit’s “phase out” begins at $100,000 per year for joint filers.  Since you cannot claim both the AOC and the Lifetime Learning Credit in the same year, if you qualify for the full AOC, you cannot use this credit.  However, the Lifetime Learning Credit can be used for part time students and for courses to improve your job skill, while the AOC only applies to full time college students.

College expenses will continue to rise.  It is more critical than ever for families to begin early planning to meet these high expenses.  As taxes rise, the tax savings from these programs will become an ever more important piece of your child’s or grandchild’s college education planning.

Saving Taxes While Paying for College

Posted on August 19th, 2009 in Educational Expenses, Newsletter Articles, Taxes by wayne


As your children (or grandchildren) head back to school, you may be wondering how you will ever afford their college education.  A four year education in a public university costs approximately $55,000 and a degree from a private university costs $132,000. 

In 15 years, these costs are estimated to rise to $316,000 for four years at a private university and $133,000 for a public university.  Since educational expenses are not tax deductible, with a combined state and federal tax bracket of 35%, the required before tax income to pay for these expenses is $486,000 for a private college and $205,000 for a public college.

Let’s look at two approaches to college savings where Uncle Sam can help pay these huge expenditures.

529 College Savings Plans – 520 College Savings Plans allow for a parent, grandparent or other family member to set up a plan for each child.  An individual may provide up to $13K annually or a couple can fund up to $26K annually for each child’s plan, using the annual gift tax exclusion.  A unique aspect of the 529 plan is the ability to pre-fund up to five years ($130K for a couple or $65K for an individual) when the plan is established.  

The investment growth in a 529 plan is not  taxed.  As long as the funds are eventually withdrawn for higher education expenses, associated with a college or graduate school, the 529 investment and its growth can be withdrawn tax free.

As an example, assume your daughter is just entering 1st grade.  Wishing to help pay for their granddaughter’s education, your parents put $100K into a 529 savings plan, with their granddaughter named as the beneficiary.  Assuming an 8% annual return on the 529 plan, when your daughter enters college, the 529 plan will have $252K available for college expenses.  If your combined federal and state tax bracket is 35%, the tax free withdrawal of 529 funds could save as much as $53K in income taxes.

529 plans offer great flexibility to the person who funds the plan.  In the example above, if the granddaughter decides to go to a public university and does not require the full amount remaining in her plan, the grandparents can change the beneficiary to another grandchild, who could then use the remaining 529 funds for their higher education.  The grandparents can even provide the remaining funds to grandnieces or grandnephews.

With a 529 plan, you must choose your investments from the investment options offered by the plan administrator.  However, the plan owner (funder) can change investment options once every 12 months.  If a better plan becomes available, you can even transfer the fund assets to a different plan as often as once per year. 

Coverdell Education Saving Accounts – Another way to fund educational expenses is through the Coverdell ESA.  Contributions to a Coverdell ESA can be made for any child, under the age of 18.  The maximum funding per child, regardless of the funding source, is $2,000 per year.  Thus, a family with five children can put aside a maximum of $10K per year into the Coverdell ESAs.

Similar to the 529 plans, all growth and income in a Coverdell ESA is never taxed, as long as the funds are withdrawn for qualified educational expenses.  Unlike the 529 College Savings plan, the Coverdell ESA funds can also be used for K-12 educational expenses.   Also, Coverdell ESAs can only be fully funded by individuals with annual income below $95K and couples with income below $190K.

If there are funds remaining in an ESA account, the Coverdell ESA funder may transfer funds from that ESA account into another ESA account as long as both account holders are under age 30.

If funds are not used for qualified educational expenses Coverdell ESAs and 529 plans have severe tax consequences.  In both cases, the income is taxed as ordinary income plus a 10% penalty amount is applied to the income.   However, the flexibility to transfer funds to other family members and the significant tax savings make both plans attractive to any family that is facing the significant costs of higher education.  

Coverdell Education Savings Account

Posted on October 17th, 2007 in Educational Expenses by wayne

A Coverdell Education Savings Account (ESA) is an ideal way for young families to save for their children’s educational expenses.  With a Coverdell ESA, you are able to save $2,000 annually, for each of your children, from the time they are born until they reach age 18.  The Coverdell ESA deposits may be made by anyone, providing a great way for grandparents to help in fund their grandchild’s education.

You may set up a Coverdell ESA account at any institution that offers IRA accounts.  A Coverdell ESA has tax advantages that are similar to a Roth IRA.  While the initial contribution to the account is not deductible, all growth and income from the account escapes taxation, as long as the withdrawn funds are used for education related expenses.  These expenses can include tutoring, computer equipment, room and board and even school uniforms.

Funds from a Coverdell ESA may be used to pay for educational expenses from kindergarten through graduate school.  The longer that the funds are allowed to grow, the greater will be your financial benefit.

Your may fund both a Coverdell ESA and a Section 529 College Savings Plan in the same year.  A Coverdell ESA has Adjusted Gross Income limits for the contributor of $190,000 for couples or $95,000 for individuals.  If your income exceeds that limit, perhaps your parents or even your child’s godparents might be willing to make the contribution.  Remember, you can always gift up to $12,000 to anyone, without any gift tax consequences.

If the funds in a Coverdell ESA are not consumed before the beneficiary reaches age 30, the beneficiary receives the remaining funds and must pay both income taxes and a 10% penalty on the remaining funds.  To avoid this problem, a rollover of the remaining Coverdell ESA assets may be made to a sibling, a niece, a nephew or even the beneficiary’s child.

Start a Coverdell ESA as early as possible in your child’s life to help fund their education.  As Robert and Cindy find in Financial Abundance Guide, the $2,000 per year that they invest for each of their children grows to $54,300 by the time the child is 15, with an 8% annual return on the invested funds.   Tax free income makes the Coverdell ESA  an excellent vehicle for educational savings.

Section 529 Plans for Grandparents

Posted on September 8th, 2007 in Educational Expenses by wayne

As you may already be aware, a Section 529 College Savings Plan is an excellent method of saving for a child’s college education.

The funds invested in a Section 529 College Savings Plan will grow on a tax-free basis and, when used for secondary educational expenses, can be withdrawn with no taxes ever paid. By never paying taxes on the plan income, you are effectively buying educational services at a “discount”, equal to the combined federal and state taxes that you would have paid on the plan’s growth.

What you may not know, are the benefits that Grandparents have when setting up a Section 529 Plan. The person that sets up the plan is the plan owner, with another person named as the beneficiary.

Setting up the plan is considered a completed gift to the beneficiary and is covered by the federal gift tax annual exclusion of $12,000. However, with a 529 Plan, you may elect to make a gift of up to 5 times the annual exclusion rate, allowing up to $60,000 to be given to each beneficiary or $120,000 if your spouse agrees to “gift splitting”.

If you are concerned that your estate may someday be required to pay estate taxes, this is an excellent way of removing up to $120,000 for each grandchild from your estate.

The unique part of a 529 Plan for Grandparents is that, even though the funding is treated as a completed gift, you, as the owner, have virtually complete control over the 529 Plan funds. In the future, you can change the beneficiary to anyone in your direct family tree.

You can even ask for the money back, if your finances change. If you ask for the money back, you must pay ordinary income taxes plus a 10% penalty on the 529 Plan’s income. However, all of the money used to fund the plan comes back to you.

The Section 529 College Savings Plan is the only plan, I know of, that allows you to give your money away as a completed gift, and still have virtually complete control of the funds. You can even choose the successor owner of the plan if you were to die.

For more information on the benefits of a Section 529 Plan and how to choose the best plan for your needs, go to www.savingforcollege.com.