Do’s and Don’ts of College Planning – Tax Credits and Other Options

College funding is often like a chess game. You have to move pieces around carefully.  Tax laws are chess moves that can be played in the years the dependent is a student.

The American Opportunity Credit gives you a tax credit for college expenses.  The first $2,000 of college expense is credited to your taxes – 40% is refundable, 60%reduces your taxes but is not refundable.  25% of the next $2,000 is eligible for credit.  The total credit is $2,500 in one year.  This credit can be used on first 4 years of undergraduate courses.

Lifetime Learning Credit may also be used to offset college expenses.  This credit is non-refundable, but does reduce your tax bill.  The credit is 20% of college expenses up to $10,000 or maximum of $2,000.  This credit can be applied to both undergraduate and graduate work.

Both credits are applied to qualified college expenses defined as tuition and fees, books, supplies, and equipment.  Room and board is not qualified expenses.  These tax credits do have income limitations.  But they can be used for taxpayer, spouse or dependents.

Another savings option available to some parents comes from their employer’s stock purchase program.  Frequently, these programs allow employees to buy at a 10% – 15% discounted price.  And you can payroll deduct giving you disciplined savings.   This is another way to accumulate assets, leave it as an asset in your financial aid calculation with only 10% counting towards family contribution.  It is also in your name, so if it isn’t needed for college, you can use it as you please.  Several clients have had this option work well for them.  One client set aside stock from a previous employer for his children.  Both children received full ride scholarships.  The clients now own a cabin.  FLEXIBILITY!!!

Another option you can use similar to the Roth IRA is a traditional IRA.  While this will come out as taxable income to the parent, it can be withdrawn free of the 10% early distribution penalty.  A word of caution:  The 1099R will be issued with reason listed as unknown.  Higher education expenses are one of the penalty exemption reasons.   Be sure you, or your tax preparer, are aware of this and complete the early distribution form correctly.    Again, be careful to not jeopardize your own retirement in helping your child.

After all these many suggestions of HOW to save – WHAT investments do you use?  To receive tax deductions on your state income tax return, you may have to use the state program.  Regardless of which fund family you use, the investing philosophy is the same.  It is similar to retirement planning.  The younger the child is, the more aggressive you can be in your investing.  The closer to college the child is the more principal preservation becomes your focus.  In the 2008 melt down, I called my clients with children nearing college age to tell them to take a couple years tuition to cash.  They did not have recovery time before tuition would be due.  You want the funds to be there when the child is ready to start college.  And you want to sleep peacefully.


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