SAVING FOR COLLEGE THE SMART WAYSep 9th, 2011 | By Staff | Category: Editorials
By Mark Buescher, C.P.A.
With college football season now in full swing, last week I attended the kick-off dinner for the Madison County Seminole Boosters Club. I sat at a table with a Madison couple with two beautiful, well mannered daughters, ages 15 and 13.
Of course, being at a college boosters club dinner, the conversation quickly turned to a discussion of schools the two young ladies might be interested in attending. Naturally, Florida State University was discussed. But also, two other contenders were mentioned – the University of Florida and the University of Georgia. When Georgia was mentioned, my first thoughts were “ouch – out of state tuition.” I could already feel the financial pain by the look on the dad’s face.
With tuition costs climbing and out-of-state tuition a real possibility, setting aside funds for college can be a formidable task. Here’s a quick review on the various programs and the tax breaks you can use to lessen the financial burden of college.
The first program that comes to mind is Coverdell education savings accounts. These accounts offer several advantages over other college savings plans. First, there’s flexibility. Like an IRA, you can choose from a wide variety of investments to meet your individual needs. Also, funds in the account can be withdrawn tax-free if used for qualified education expenses such as tuition, room, and board, books, even a computer. Unlike other programs, qualified expenses include costs of elementary and secondary school.
However, the maximum annual contribution for a beneficiary is $2,000 – from all sources. Also, funds must be used by age 30. If the funds are not spent on college by the time the beneficiary is 30 years old, the unspent money must be withdrawn (subject to income tax and a 10% penalty) or rolled over into another family member’s education savings account.
Another great college savings investment vehicle is a Section 529 plan. If you want to put a large lump sum into a college savings account, a Section 529 plan may be your best option. In this type of account, there are no phase-out limits for high earners, and plan sponsors set maximum allowable contributions.
Established by all 50 states, these plans provide a way to set aside after-tax dollars in an account that can grow tax-free until the child needs money for post-secondary education. Funds can then be withdrawn tax-free to pay for qualified expenses, such as tuition and books.
But what happens to the account if your child receives a substantial college scholarship, or decides to skip college and step straight into the workforce? Such contingencies are no problem for a 529 plan, because you can re-direct the beneficiary to another child, family member, or even yourself.
Another consideration for college savings accounts is a custodial account. With custodial accounts (Uniform Transfers to Minors Act or UTMA), you can generally invest in a wider variety of investments than with a 529 plan. The proceeds can be taken out penalty-free – even if used for something other than education. The biggest potential disadvantage is that you gift the funds irrevocably to the child. At a certain age, your child controls the account and could spend the funds on a sports car instead of college.
Although not a savings plan, one of the best tax breaks for education expenses is the American Opportunity Credit. With this credit, you reduce your taxes dollar for dollar for education expenses incurred during four years of college. The credit has an annual limit of $2,500 per student.
Another tax break for education expenses is the Lifetime Learning Credit. The limit for this credit is $2,000 per tax return, and qualified expenses include tuition, fees, and books for both undergraduate and graduate programs. You’re limited to using only one credit (American opportunity or lifetime learning) per student.
There are other options as well. Roth IRAs and U.S. savings bonds are additional options worth considering. You may also qualify for an interest deduction on education loans.
Obviously, there are many options and choices for savings for college. But with the right planning and proper investment vehicles, the financial burden can be substantially reduced.
Mark Buescher, CPA is owner and principal of Buescher and Ruff, LLC, a local full service accounting firm in Madison, specializing in tax preparation, business consulting and tax planning. Tax laws contain varying effective dates and numerous limitations and exemptions that cannot be summarized easily. For details and guidance for your specific situation, contact your tax advisor