By Bennett Whitlock, CRPC®, Private Wealth Advisor
The best defense against rising costs is to save early and often. While there are a variety of accounts you can open and other ways to save for college, 529 plans, Coverdell and custodial accounts offer possible tax benefits.
These plans, named after a provision in the tax code, are one of the most popular ways to build savings over time. A parent or even a non-relative can establish a 529 plan for a student, with the ability to switch potential beneficiaries any time. The person establishing a 529 account retains control over the assets and how they are used. Any earnings grow on a tax-deferred basis, and any withdrawals used to meet qualified higher education expenses of the named beneficiary are income-tax-free. This is a significant incentive to save for college and offers a great deal of flexibility due to the high maximum contribution amounts, which vary by state. While contributions to a 529 plan are not deductible for federal income tax purposes, many states allow for deductions/credits on state income taxes. Check your state’s laws and consider making a contribution before the end of the year to claim a deduction/credit on your state return.
The Uniform Transfer to Minors Act (UTMA) and Uniform Gifts to Minors Act (UGMA) custodial accounts offer a way to transfer assets to your minor. However, because the student is the account owner, the assets may affect his or her eligibility for financial aid. The tax benefits to the donor include reducing the size of the donor’s estate for estate tax purposes and the ability to exclude earnings on these assets from the donor’s income taxes, though income tax rules still apply to the child (and kiddie tax could have an impact).
A Coverdell education savings account, a specific type of trust or custodial account, allows you to save for higher education, private elementary, middle or high school education expenses. Contributions are limited at $2,000 a year for a single beneficiary and are only allowed until the minor turns 18. Any earnings in the account grow tax free, and there’s no federal tax when the money is withdrawn for qualified expenses. The account funds must be distributed before the designated beneficiary turns 30.
Tax-saving strategies when making tuition payments
Once you transition to paying for college expenses, there are potential tax credits and deductions that may help you save money on your tax bill.
Tax credits provide a dollar-for-dollar reduction in taxes due.Credits can be earned in the year tuition is paid, in many cases, even if it is for the academic period beginning in January through March of the following year. Payments made by the end of 2018 may qualify for a credit on this year’s tax return. Two credits you may qualify for include the American Opportunity Tax Credit and the Lifetime Learning Credit. Income restrictions and other qualifications apply, so work with your tax professional, who can help you determine the best tax strategy for your situation.
You may qualify for deductions related to education expenses at the federal and/or state level. For example, a federal income tax deduction of up to $2,500 is available for the interest paid on a qualified education loan; however, certain income restrictions apply.
Consult with your financial advisor about the best college saving strategies for your situation and with your tax advisor on potential tax-saving provisions of the law.
Bennett Whitlock, CRPC ®, is a private wealth advisor and managing director with Whitlock Wealth Management, a franchise of Ameriprise Financial Services Inc. Learn more at WhitlockWealth.com or call 703-492-7732.