As college costs continue to rise, it’s more important than ever for families to be aware of all the tax incentives available to them as they try to maximize the potential of their savings.
There are a range of savings options offering different tax advantages. The following is a summary of the more popular savings vehicles and their benefits.
529 Savings programs
- Tax-free appreciation of assets and tax-free withdrawals for qualified higher education expenses
- Some states may provide additional tax benefits
- Contributions are limited to the federal annual gifting limit ($14,000) with a special provision allowing an up-front five-year gift tax election (currently $70,000)
Coverdell savings accounts
- Similar to 529 plans but total contributions per student are limited to $2,000 annually
- Can be utilized for elementary or secondary school expenses (unlike a 529)
- Available to taxpayers with income (modified adjusted gross income) of less than $110,000 ($220,000 for couples)
U.S. savings bonds
- Taxpayers with income less than $91,000 ($143,950 for couples) may exclude a portion of interest from these bonds if funds are used for qualified education expenses
Custodial (UGMA or UTMA) accounts
- Accounts established for the benefit of minors with no requirement that funds be used for educational purposes
- The first $1,050 in earnings is exempt from income taxes, the next $1,050 in earnings is taxed at the child’s tax rate (known as the “kiddie tax”), additional income generally taxed at parent’s tax rate
American Opportunity Tax Credit (AOTC)
- $2,500 tax credit per student available to offset qualified higher education expenses
- Available to taxpayers with less than $90,000 in income ($180,000 for couples)
Lifetime Learning Credit
- $2,000 total (per family) tax credit available
- Available to taxpayers with less than $64,000 in income ($128,000 for couples)
Deduction for qualified tuition
- Can reduce the amount of income subject to tax by up to $4,000, available to taxpayers with less than $80,000 income ($160,000 for couples)
Deduction for student loan interest
- Can reduce the amount of income subject to tax by up to $2,500
- Available to taxpayers with less than $80,000 in income ($160,000 for couples)
Direct tuition payments
- Unlimited gift tax exclusion for payments of tuition made directly to an educational institution
Taxpayers need to be aware that in certain cases there are rules against combining these tax benefits (e.g., utilizing the American Opportunity Tax Credit and taking a deduction for qualified tuition expense). For more information, they should refer to IRS publication 970, Tax Benefits for Education, or consult a qualified tax professional or financial advisor.
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