As a parent with potentially college-bound children, you are probably concerned with setting up a financial plan to fund future college costs!
The scary part is how much college might actually cost if you currently have young children. I have used the “College Cost Projector” calculator on the collegeinvest.org website to determine the potential costs for our children (ages 5 and 8). It is a daunting number to look at and I now hope our kids will get a full academic or athletic scholarship!
Here are some tax-advantage strategies to save for future college costs. Please discuss these strategies with your tax or financial advisor as each one has limitations that might not be fully explained here and depend on your personal tax situation such as income and filing status. I also have limited the discussion on each strategy due to space limitations.
Series EE U.S. savings bonds. Series EE U.S. savings bonds offer two tax-savings opportunities: first, you don’t have to report the interest on the bonds for federal tax purposes until the bonds are actually cashed in; and second, interest on “qualified” Series EE (and Series I) bonds may be exempt from federal tax if the bond proceeds are used for qualified college expenses (room and board does not count). Other tax-exempt bonds can also be used.
Qualified tuition programs. A qualified tuition program (also known as a 529 plan) allows you to make contributions to an account set up to meet a child’s future higher education expenses. Qualified tuition programs can be established by state governments or by private education institutions. Contributions to these programs aren’t deductible for federal income taxes but can be on your state tax return. The earnings on the contributions accumulate tax-free until the college costs are paid from the funds. Distributions from qualified tuition programs are tax-free to the extent the funds are used to pay qualified higher education expenses.
Coverdell education savings accounts. You can establish Coverdell ESAs (formerly called education IRAs) and make contributions of up to $2,000 annually for each child under age 18. This age limitation doesn’t apply to a beneficiary with special needs, defined as an individual who because of a physical, mental or emotional condition, including learning disability, requires additional time to complete his or her education. Although the contributions aren’t deductible, income in the account isn’t taxed, and distributions are tax-free if spent on qualified education expenses.
Retirement contributions by your children. If you are a business owner and can hire your child under a valid employment agreement for their age, your child can contribute to an IRA that can be used for education expenses with little tax consequences.
There are many ways to pay for your child’s college expenses including scholarships, student loans, employer educational assistance programs, tuition reduction plans for employees of educational institutions, student loans, bank loans, borrowing against retirement plan accounts, and potentially taking withdrawals from retirement plan accounts (I caution against this last one, though).
Not all of the above breaks may be used in the same year, and use of some of them reduces the amounts that qualify for other breaks. So it takes planning to determine which should be used in any given situation.