Tax-Favored Ways to Save for College
by Bobbie Shocket Lazarz
If you're faced with college costs, either soon or down the road, the federal government, along with the states, offers several tax-advantaged ways to help you save. Here's a rundown of your options:
Coverdell education savings accounts
Coverdell education savings accounts offer you a tax-free way to save for your child's elementary, secondary, and college education expenses.
You can contribute up to $2,000 a year to an education savings account per child. You can make contributions anytime after a child is born until the child's 18th birthday (with an exception for special needs beneficiaries).
Although contributions aren't tax deductible, earnings accumulate tax deferred. Then withdrawals to pay qualified education expenses are free from federal taxes. Those who meet the income limits--including parents, grandparents, and children themselves--are eligible to contribute.
If you're a married taxpayer who files jointly with modified adjusted gross income of less than $190,000, you qualify for the full contribution. If your income is between $190,000 and $220,000, you qualify for a partial contribution. If you're a single taxpayer these limits are $95,000, and between $95,000 and $110,000 respectively.
If your income exceeds these eligibility limits, you can give money to a child and he or she can make the contribution (assuming the child meets the income limits).
For the tax rule details, refer to IRS Publication 970, Tax benefits for higher education.
529 college savings programs
529 college savings programs offer you a tax-free way to save for future college costs. In general, college savings programs don't have any eligibility income limitations.
Qualified withdrawals of earnings from college savings programs are free from federal tax. Plus, most states exempt earnings from state income tax, and some states allow state residents to deduct the full or partial amount of their contribution from state income taxes.
Grant aid and education tax credits and deductions reduce the cost of college for many students and families.
There are two main types of 529 programs and each state's program has its own terms and features.
Prepaid tuition plans allow you to pay tuition in advance and lock in the cost based on today's tuition prices. These plans pool investments and aim to keep pace with tuition increases in that state.
You can use savings in prepaid tuition plans for tuition at any eligible public university or private college in the country. The amount, however, is based on tuition costs at a state's public universities.
College savings plans allow you to save money in a special college savings account for tuition and fees, books and supplies, and certain room and board expenses. These plans provide variable rates of return based on the investments you choose from the available options. You can use savings in these types of plans at any eligible public or private college or university nationwide.
For the details about College Savings Plans, refer to these online publications: A Guide to Understanding 529 Plans by the College Savings Plan Network, and College Savings Plans � School yourself before you invest.
U.S. savings bonds
Series EE bonds purchased after 1989 and Series I bonds purchased anytime have a tax-savings college education feature. If you meet the conditions, you may be able to exclude some or all of a bond's interest from your federal income tax when you use the bond to pay qualified higher education expenses.
Although tuition costs are still on the rise, the rate of increase has slowed from the previous two years at public universities, and is about the same as the previous year at private colleges.
Qualified higher education expenses are tuition and fees paid to an eligible postsecondary educational institution. Contributions to state-sponsored 529 college savings programs and contributions to an education savings account also are qualified higher education expenses.
The expenses may be for the benefit of you, your spouse, or a dependent whom you claim an exemption for on your federal tax return. To qualify for the exclusion, you must meet the specified conditions. For specifics, visit the government Web site.
What students actually pay
When reporting these costs, the College Board emphasizes that published tuition prices are not what most students actually pay. In fact, grant aid and education tax credits and deductions reduce the cost of college for many students and families.
Qualified withdrawals of earnings from college savings programs are free from federal tax.
Consequently, the average amount students actually paid for annual tuition and fees at public four-year universities--after receiving grant aid and taking advantage of tax breaks--was reduced from the published price of $5,491 to $2,200.
At private four-year colleges, the average amount students actually paid was reduced from the published price of $21,235 to $11,600.
Nonetheless, even with grant aid and tax breaks, college students receive more than one-half of their financial aid in the form of loans, and aid in the form of loans is growing at a faster pace than grant aid.
Adding up all the costs
When tuition and fees, room and board, books and supplies, personal expenses, and transportation are added all together, average published expenses for one year of college total $15,566 for a four-year public university and $31,916 for a four-year private college.
And when you add up all these costs for attending college for four years, the average cost of a four-year college education is estimated at $69,108 for a public university and $141,703 for a private college (assuming an average 7% annual increase in expenses).
Bobbie Shocket Lazarz, Certified Financial Planner Professional TM, MSW, MBA, is the primary author of the CUNA Mutual Group's Education Center Web site. Lazarz has been educating credit union members about personal finance for 15 years. The CUNA Mutual Group is the leading provider of financial services to credit unions and their members nationwide.
December 12, 2005
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