Tax breaks to help you pay for your college education
It is often said that buying a home is the biggest investment most of us will ever make. But if you have a few kids, the cost of sending them to a four-year college might even exceed that pricey position. Three kids – or at least one with Ivy League aspirations? It’s a house and a holiday home.
The average annual cost of tuition, room, and board for a public four-year college in the state in 2021 was $22,690 per year, while the average annual cost for a private four-year was $51,690, according to the College Board. But for Ivy League and many selective private colleges, the annual cost is over $75,000. Fortunately, just as the government offers tax incentives to homebuyers, the tax code includes many credits and deductions intended to reduce the cost of a college education.
Save tax-free with a 529 plan
The most effective way to save for college is to start contributing to a 529 college savings plan while your child is still in diapers. Contributions are not deductible on your federal tax return, but the money grows tax-free and withdrawals are not as long as the money is used for eligible expenses including tuition, housing and meals, books, computers and the Internet. to access. If your child receives a scholarship and does not need the money, you can change the beneficiary to another eligible child or family member.
Some states allow you to deduct a portion of your contributions from your state taxes, usually as long as you invest in your own state’s plan (for an overview, go to www.savingforcollege.com). If you don’t use the money for college, the earnings portion of your account will be subject to income tax and a 10% penalty.
Some critics claim that 529 plans unfairly benefit wealthy families, and there’s no doubt that you can rack up a lot of money in these plans, up to $550,000 in some states. But most plans allow you to start small – $25 is a common minimum investment requirement, and some have no minimum. If you start early, even a modest monthly investment will accumulate over 18 years.
Other family members can also contribute to a 529 plan for your children, and an upcoming change in federal financial aid rules removes a downside to these accounts. Currently, distributions from a 529 plan held by grandparents (or other non-parents) are treated as student income on the Free Application for Federal Student Aid (FAFSA), potentially reducing the amount financial aid for which the student is eligible. Beginning with the 2024-2025 school year, withdrawals from the 529 plan of a grandparent (or other non-parent) will no longer be counted as student income.
The change will benefit grandparents in several ways, says Mary Morris, executive director of Virginia529. By setting up their own plan (instead of contributing to a parent’s 529 plan), grandparents will be eligible for a tax deduction if their state offers one, even if the beneficiary lives in another state. Plus, grandparents will have the ability to switch beneficiaries or use the money themselves if they need to, Morris says.
This is especially important for grandparents who want to use a 529 plan as an estate planning tool. The maximum amount that grandparents or others can donate in 2022 without filing a tax return is $16,000 per beneficiary (a married couple can donate up to $32,000 per beneficiary). But if you contribute to a 529 plan, you can combine five years of gift tax exclusions into a single year, which means you can contribute up to $80,000 in 2022 ($160,000 for a married couple). . In addition to reviving a 529 plan, this strategy will reduce the size of your estate for property tax purposes. While the 2022 federal estate tax exemption is $12.06 million ($24.12 million for a married couple), several states have much lower estate tax exemptions . And unless Congress agrees to expand the provisions of the Tax Cuts and Jobs Act of 2017, the federal estate tax exemption will drop to $5.49 million after 2025.
Grandparents (or other wealthy parents) can also reduce the size of their estate by contributing directly to your child’s school. These payments are gift tax exempt as long as they are made directly to the child’s college or university to cover tuition. Some grandparents may prefer this option over a 529 plan because it allows them to stay in control of their money until the child goes to school. However, these payments may reduce the child’s eligibility for financial assistance. And with changing federal financial aid rules due to take effect in two years, college savings plans may be a better option.
Use savings bonds to save for college
In recent months, yield-hungry, risk-averse investors have crowded into Series I inflation-adjusted savings bonds, which pay an annualized rate of 9.62% for bonds sold from May through October. In addition to offering high yields, these bonds could be a tax-efficient way to save for college.
Under certain conditions, interest from EE or I Savings Bonds is tax-free if the money is used to pay tuition and fees for yourself, your spouse, or a dependant. You can also qualify for tax exclusion if you redeem the savings bonds and deposit the money into a 529 plan within 60 days.
To benefit from this tax advantage, the savings bonds must be issued in your name (or in your name and that of your spouse as co-owners) and not in that of your child. The original owner must also be at least 24 years old on the date the bond was issued. There are also income limits on this tax relief: for 2022, the exclusion is phased out if your modified adjusted gross income is between $85,800 and $100,800 for single filers and between $128,650 and $158,650 for married taxpayers filing jointly. These thresholds are adjusted each year for inflation, so if your child is still years away from college, it’s hard to predict whether you’ll qualify for the tax relief when you pay off your obligations.
The maximum you can invest in I Bonds is $10,000 per year (if you’re married, you and your spouse can save up to $20,000). You can buy an additional $5,000 in paper bonds with your income tax refund. When you buy savings bonds, you must hold them for at least one year. If you redeem them before five years have passed, you will lose the previous three months of interest. Note that if you already have EE or I bonds tucked away in a drawer somewhere, you may be able to redeem them tax-free, assuming you meet income restrictions. The exclusion applies to EE bonds issued after 1989 and to all I bonds.
Tax breaks when you pay for college
No matter how diligently you save, chances are you’ll have to write checks when your child starts school. The good news is that you may be able to get some of that money back when you file your tax return.
The American Opportunity Tax Credit is your first stop. This credit, available for expenses incurred by students in their first four years of undergraduate study, is worth up to $2,500 in tuition, fees, and books per child. If you have more than one child in college, you can claim more than one American Opportunity credit.
There are income caps: in 2022, the credit will be phased out for single taxpayers whose modified adjusted gross income is between $80,000 and $90,000 and for married taxpayers who file a joint return with MAGI between 160 $000 and $180,000.
If your child does not qualify for the American Opportunity Credit, you can still apply for the Lifetime Learning Credit, which is worth up to $2,000 in 2022. Unlike the American Opportunity Credit, the Lifetime Learning Credit is not limited to education undergraduate. expenses, and the credit does not apply only to students who attend at least half-time. There is also no limit to the number of years the credit can be claimed for each student. You can claim the credit for yourself, your spouse or your dependent up to $2,000 per family each year. The credit is phased out if your MAGI is between $80,000 and $90,000 for single taxpayers and between $160,000 and $180,000 for married couples filing jointly.
Scholarships can provide much-needed funds for college, and in many cases the money is tax-free, but not always. A scholarship or fellowship is excluded from taxable income if the money is used for tuition or fees required for registration or attendance, or for books, supplies, equipment or other expenses that are necessary for a course. If the scholarship exceeds your child’s education expenses or is for non-educational purposes, such as room and board, the money is taxable. Similarly, the money is taxable if the scholarship represents payment for teaching, research or other services.
Tax relief for interest on university loans
If your savings aren’t enough to cover the cost of college, you or your child may need to take out a student loan to cover it. Once you or your child start repaying these loans, you may be able to deduct up to $2,500 in interest on your federal tax return. The deduction is claimed as an adjustment to income, so you can claim it even if you don’t itemize. However, the deduction is phased out if your MAGI is between $70,000 and $85,000 ($140,000 and $170,000 for co-filers).
If you are repaying your child’s student loans, your child can still claim the deduction because the IRS treats transactions as if the money had been given to the child, who then paid the debt. You cannot claim the interest deduction, even if you pay the bill, because you are not responsible for the debt. However, if you took out a federal PLUS parental loan to help pay for your child’s college education and you fall within the above income thresholds, you can and should claim the tax deduction.