Saving for a child’s college education used to be considerably easier and more economical. There were also fewer tax incentives to contend with. The tax code has developed over time, resulting in a bewildering array of tax-advantaged college savings accounts, tax credits, and other tax incentives available to families trying to pay for their child’s college education. We’ll look at the tax implications of several college savings schemes in this article.
Important Points to Remember
- Every college savings plan has its own set of limitations, which are determined by the parents’ income level.
- Through a 529 Plan or a Coverdell Education Savings Account, parents can invest in bond programs or mutual funds.The Lifetime Learning Benefit is a tax credit that can save you up to $2,000 per year on your taxes.
- For a percentage of their educational costs, full-time employees are eligible for tax-free employer contributions.
College Savings Plans with Tax Benefits
In 1990, the first tax-advantaged college savings plan was established. The Education Savings Bond Program insured that interest generated on specific government bonds redeemed to pay for a child’s education would not be taxed. Series EE and Series I bonds are both eligible.
To qualify, the bond must be in your name or your name and your spouse’s name. This means that any bonds issued in your child’s name will be ineligible. Furthermore, you won’t qualify for this tax relief until your MAGI in 2021 is less than $153,550 for married taxpayers and $97,350 for single filers (for 2022, MAGI must be less than $158,650 for married filers and $100,800 for single filers).
If you want to save for a child’s college education through mutual funds, you might want to look into a 529 Plan or a Coverdell Education Savings Account (ESA). President Donald Trump signed the Setting Every Community Up for Retirement Enhancement (SECURE) Act into law in December 2019, allowing up to $10,000 to be used for student loan payments in 529 and ESA plans.
These funds can also be used to pay for an apprenticeship program, as long as the program has been approved by the US Department of Labor.
As long as the money is invested, both 529 Plans and Coverdell Educational Savings Accounts allow tax-deferred growth. However, they are not the same. These plans differ in the following ways:
- Maximum Annual Contribution: You can put up to $2,000 per year into an ESA for each child.
- Beneficiaries of 7 529 plans can have a maximum account balance of $235,000 to $529,000, depending on the state.
- Tax-Free Distributions: Distributions from both plans are tax-free if they are utilized to pay for eligible educational expenditures. However, you can use an ESA to pay for private kindergarten, elementary school, and high school tuition tax-free.
- If your MAGI is between $95,000 and $110,000 and you file a single return, or if your MAGI is between 190,000 and $220,000 and you file a combined return, the amount of your ESA interest exclusion is gradually lowered. If your MAGI exceeds the limits, you will be unable to exclude any interest. There are no income restrictions with a 529 Plan.
You might be thinking which opportunity is the best fit for you. There isn’t a straightforward answer. It all relies on your unique circumstances and the amount of money you expect to set aside for your child’s education.
With so many different tax credits to choose from, coordinating options to reduce the after-tax cost of sending a child to college can be difficult.
College Tuition Tax Credits
The Lifetime Learning Credit is a federal tax credit that equals 20% of the first $10,000 in eligible educational costs paid each year, giving you a tax savings of up to $2,000 per year.
There is an income threshold for these tax reductions, as there is for many other rules. For full credit in 2022, your MAGI for individuals must be between $80,000 and $90,000, and for married couples filing jointly, it must be between $160,000 and $180,000. (unchanged from 2021 figures).
Contributions to a 529 plan may also be eligible for a tax benefit in some jurisdictions. Indiana taxpayers, for example, can claim a state income tax credit equal to 20% of their donations to a CollegeChoice 529 account, up to $1,000 per year ($500 if married filing separately). In Vermont, filers can claim a 10% tax credit on gifts of up to $2,500 for a single beneficiary or $5,000 for a joint beneficiary, for a total tax credit of $250 per beneficiary.
Additional Tax Breaks
If you work full-time while attending classes, the government will reimburse your employer up to $5,250 per year for tuition, books, supplies, and equipment. This tax-free advantage is applicable to undergraduate and graduate-level classes under current standards.
Don’t forget to factor in the interest on your student loans. You can deduct up to $2,500 in student loan interest each year. This non-itemizer deduction begins to phase down in 2021 for married couples earning over $140,000 ($70,000 for single filers) and totally phases out at $170,000 ($85,000 for single filers).