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4 Best Tax Advantaged Ways to Save for College

by
Lee Reams, BSME, EA
on
8/24/2015
4 Best Tax Advantaged Ways to Save for College

Retailers are letting us know that summer is as good as over as they advertise back-to-school sales and start setting up their Halloween displays. While the kids prepare themselves for another year of learning, the families that are planning for their future find themselves confused as to the smartest way to save for college, especially as the stock market takes us on another wild ride. 

The government has provided a number of tax-advantaged ways for parents, grandparents and others to save for education, whether for private school or college, and educating yourself about the available plans is the best way to determine which will work best for you.

The top choices include:

Taking out Student Loans

Though it would be nice to get financial aid or a scholarship, or to have enough savings or income to simply pay for college out-of-pocket, those options are not necessarily available to all. Taking advantage of loans is an option that many pursue, but it is important to understand that the interest rates that will be charged are actually higher than most home equity loan terms. When you consider that taking out a second mortgage will also allow a much longer period of time to pay back the loan, as well as lowering the payments to be made, it is easy to see why this is an option worth considering. Still, there certain disadvantages to going this route, including the fact that the interest that you pay may not be deductible. Only the first $100,000 of interest on home equity debt is deductible, and that is only available to those who itemize. You also have to consider whether the alternative minimum tax applies to you. Another consideration is that only student loans allow itemization as single-purpose loans, but the amount is limited. Only $2,500 can be deducted per year, and for joint filers with adjusted gross income between $130,000 and $160,000 (and unmarried taxpayers earning between $65,000 and $80,000) there are phase outs.

Tax Credits for Education

Taxpayers who are paying for post-secondary education tuition are allowed to choose between two different tax credits, and understanding the best way to utilize these credits can be extremely beneficial. The American Opportunity Credit and the Lifetime Learning Credit. The American Opportunity Credit provides up to $2,500 of credit for each student in a family, which can be taken during any four tax years for the first four years of schooling. This credit has a phase out between $160,000 and $180,000 for joint filers ($80,000 to $90,000 for single filers). The Lifetime Learning Credit can be taken each year, up to $2,000 per family and has a phase out of between $110,000 and $129,999 for joint filers and $55,000 to $64,999 for everybody else. Those who are married but who file separately are not able to claim this credit.

Education Savings Programs

For those who are planning long in advance, there are significant tax benefits to taking advantage of one of the two types of educational savings programs the tax code has made available. Both the Coverdell Education Savings Account and the Qualified Tuition Plan provide tax-free earnings if used for qualified educational expenses. The Coverdell account enables taxpayers to set aside $2,000 in nondeductible contributions each and every year, while the Qualified Tuition Plan, which is more commonly known as a 529 plan, allows contributions to be made each year up to the established gift tax exemption amount, which in 2015 was $14,000. The other significant difference between the two is what each may be used for. Where funds in a 529 can only allow be used for post-secondary education, and the contributor retails control of the money, the Coverdell plans can be used for any educational costs from kindergarten through post-secondary. It is also important to remember that the funds in a Coverdell account become the child’s when they reach the age of majority, and joint filers who make between $190,000 and $220,000 (or between $95,000 and $110,000 for all others) will phase out of eligibility.

Educational Savings Bond Interest

When Series EE or I savings bonds that were issued after 1989 and purchased by somebody over the age of 24 are used to pay for qualified higher education expenses, the interest on these bonds is tax exempt, though there is a phase-out of between $115,750 and $145,750 for joint filers and $77,200 and $92,200 for unmarried taxpayers. Taxpayers who file married but filing separately are not able to use this exclusion.

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Lee Reams, BSME, EA

Lee Reams, BSME, EA

Editor-in-Chief

Besides his role at CountingWorks as an educator and speaker to thousands of accountants nationwide, Lee manages a technical research service for a large group of tax accountants which sharpens his technical skills. Lee served on the Board of Blackline Systems, is a former Board of Director for the California Tax Education Council, is a Past President of the San Fernando Valley Chapter of Enrolled Agents, Member and Past Director for the California Society of Enrolled Agents.

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