In general, it is easy to know how to save for college. There are numerous websites and articles devoted to 529 College Savings Plans, Coverdell Education Savings accounts and in some cases education savings bonds. As financial advisers, we generally steer clients toward 529 Plans, as they are the most accommodating when it comes to saving significant amounts for college.
While you can open a 529 Plan in any state, and funds can be used at any qualified higher education institution, your choice may be influenced by who the plan administrator is, the types of investments, plan fees and expense, and how the investments have performed. Most states will also offer tax benefits to residents. Most Georgia residents will benefit from Georgia’s Path2College 529 Plan, as resident taxpayers can receive up to a $2,000 dollar-for-dollar state tax credit for contributions.
The harder part often comes when you have to pay for college, and you need to coordinate your withdrawals with federal income tax breaks you may be eligible for. Overall, you cannot receive more than one tax benefit for each dollar spent on higher education. One often overlooked tax break is the American Opportunity Tax Credit, worth up to $2,500, available during the first four years of your child’s college career. The credit is calculated at 100% of the first $2,000 of qualified expenses plus 25% of the next $2,000 of expenses. The credit is available to those married filing jointly with modified adjusted gross income of less than $160,000. Partial credit is available for MAGI between $160,000 and $180,000.
While you can claim the American Opportunity Tax Credit in the same year you withdraw funds from a 529 Plan or Coverdell ESA, you need to make sure the expenses you intend to cover with those funds are not the same expenses used to qualify for the tax credit. If you take out 100% of your qualified higher education expenses from your 529 Plan and apply for the American Opportunity Tax Credit, part of your 529 Plan distribution will be non-qualified, and you will have to pay income tax and possibly a penalty on the earnings portion. 529 Plan distributions are only tax free if used for qualified higher education expenses.
Other available tax credits include the Lifetime Learning Credit, which is worth up to $2,000 on the first $10,000 in qualified higher education expenses. Unlike the American Opportunity Tax Credit, the Lifetime Learning Credit is available for graduate students; however, the MAGI threshold is lower at $110,000 for those married filing jointly. A partial credit is available for those in the $110,000 to $130,000 range.
While families cannot claim both an American Opportunity Tax Credit and a Lifetime Learning tax credit for the same student in the same tax year, the two credits can be claimed simultaneously for different qualifying students in the same tax year. However, what families may not know is that you can take the American Opportunity Tax Credit or Lifetime Learning Credit on tuition or expenses that are paid with student loan money, because a loan is not a tax-free educational assistance.
When paying for higher education expenses, it can be very beneficial to seek expert help from a tax adviser or financial planner to help you coordinate withdrawals so that you do not leave any money on the table. If you’d like help coordinating your 529 Plan withdrawals, the experts at Henssler Financial will be glad to help:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166.
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