You have scrimped and saved over the years to fund your child’s Coverdell Education Savings Account and/or qualified tuition program (529 plan), but it looks like you still won’t have enough saved in time to finance the entire cost of a college education. What do you do?
Don’t go shopping for that mini refrigerator and boxes of Ramen noodles just yet. Instead, make an appointment with a tax expert who can help you develop a plan of action that strategically coordinates your child’s scholarships, education tax credits and deductions to work with your tax-favored education plan. You may be surprised at just how far you can stretch your savings.
These three college savings account strategies will get you started:
- You may already know that the American Opportunity Credit, Lifetime Learning Credit and an above-the-line deduction are available to taxpayers looking to reduce their out-of pocket, college-related expenses. Traditionally, these tax incentives are subject to certain income limitations and can only be used to cover tuition and certain fees, books and supplies – not room and board. But because distributions from a Coverdell Account or 529 plan CAN be used toward room and board (with some limitations) as well as other traditional college costs, it may be more cost effective to consider how you will pay for certain expenses to make the most of your tax incentives.
- Make sure you know the college’s policy regarding how it allocates the funds it receives from tax-favored education plans. Every school is different and knowing your school’s policy beforehand can be extremely cost effective. For example, some colleges may apply funds received directly from a plan to tuition first – instead of room and board – thereby treating those funds as they would treat an outside scholarship. If your child has a large (or full) academic scholarship awarded by the college, having the money directly transferred from the plan to the school may reduce your child’s academic scholarship while leaving YOU to foot the entire bill for the room and board. If the distribution is made directly to the child (or the parent if the plan allows this) and then paid to the college, you don’t run the risk of the college treating the plan distribution as an outside scholarship.
- Often considered the most advantageous credit for families, the American Opportunity Credit allows you to claim a tax credit of up to $2,500 (100 percent of the first $2,000 and 25 percent of the next $2,000) for qualified education expenses. But you will forfeit your chance to claim this credit if you use the funds in your education account to foot the entire tuition. Don’t just throw away $2,500. Instead, consider paying at least $4,000 of your child’s tuition and fees from a source other than your Coverdell account or 529 plan to claim the tax credit.
Coordinating education tax credits and deductions, distributions from tax-favored education accounts, and scholarships can be tricky, but they can also help you stretch your savings further than you thought was possible. Email Rea & Associates for more information.
By Cathy Troyer, CPA (New Philadelphia office)