Federal Savings Tax Benefits

Because Federal Student Aid rarely covers all college costs, the federal government created special tax benefits for students and families that save money in qualified education savings plans. Below you will find an overview of each savings plan. You can also refer to IRS Publication 970 Tax Benefits for Education for more specifics on these benefits.

Coordinating various educational aid and benefits to maximize your college cost savings is complex. It is best to consult both a tax professional and a financial planner well-versed in college planning.

Qualified Tuition Programs

Qualified Tuition Programs, also called 529 plans, are educational savings programs run by state government agencies and qualified institutions. 529 plans were designed to help families save for future college costs using two methods: pre-paid tuition plans and college savings plans.

Prepaid tuition plans allow students and families to buy credits/units at the current tuition rate (and perhaps room and board) to be used in the future. These credits/units will rise in value to match the future tuition rate and usually these plans are guaranteed by the state. This is the least popular plan since because the guarantee normally only applies to in-state public colleges. If the student decides to attend a college that is not in-state or public, then plan may pay a reduced rate. Also, prepaid plans do not cover all of the eligible education expenses that the college savings plans allow.

College savings plans allow students and families to open an account and contribute funds that are invested on their behalf by trusted financial companies. Investments are subject to risk, however different plans are available based on the account holder's risk tolerance (conservative and risky). College savings plans are either direct-sold or advisor-sold. College savings plans can be setup in nearly any state and be used to pay education expenses at a school in nearly any other state.

  • Direct-sold means buying directly from the program manager (instead of an advisor) waiving the sales fees charged by advisors.
  • Advisor-sold means buying through a financial advisor and will incur some fees that increase the cost of the plan.
Eligible Education Expenses

Eligible expenses for the prepaid tuition plans only cover tuition and fees (and maybe room and board). Eligible Expenses for college savings accounts cover tuition, mandatory fees, room and board, mandatory course-related materials (fees, books, supplies, and equipment), and special needs services. Other possible expenses that may qualify are transportation, internet access, computer and peripherals, and computer software.

MAGI and Phaseout Limits

There are no phaseout contribution limits on 529 plans. Anyone can contribute and the account earnings grow tax-free. Account earnings grow tax-free unless the account (or distributions) surpass the amount of qualified education expenses, however accounts can be rolled over to other family members attending college.

Coverdell Education Savings Accounts

Coverdell Education Savings Accounts (ESA) are trusts (or custodial accounts) designed to help families pay for future college costs. Accounts can be opened at any bank or IRS-approved entity and beneficiaries must be under the age of 18 (or have special needs).

Eligible Education Expenses

Coverdell ESAs can be used for qualified K-12 education expenses, not just higher education. Eligible expenses cover payments into a 529 plan, tuition, mandatory fees, room and board, mandatory course-related materials (fees, books, supplies, and equipment), and special needs services. Other possible expenses that may qualify are transportation, internet access, computer and peripherals, and computer software.

MAGI and Phaseout Limits

Anyone can open or contribute to a Coverdell ESA if they meet the phaseout limits. Coverdell ESAs allow for yearly contributions up to $2,000 per beneficiary no matter how many accounts and contributors the beneficiary has. Account earnings grow tax-free unless the account (or distributions) surpass the amount of qualified education expenses, however accounts can be rolled over to family members as long as they are under 30 years old or have special needs.

For single taxpayers with a MAGI of $110,000 or higher then they do not qualify to make contributions. If their MAGI is between $95,000 and $110,000 then their contributions will be reduced. Finally, if their MAGI is under $95,000 then they qualify to contribute the full amount.

For married taxpayers filing jointly with a MAGI of $220,000 or higher then they do not qualify to make contributions. If their MAGI is between $190,000 and $220,000 then their contributions will be reduced. Finally, if their MAGI is under $190,000 then they qualify to contribute the full amount.

Education Savings Bonds

Education Savings Bonds allow qualified taxpayers to avoid paying the tax owed on some or all of the interest earned from certain savings bonds when it is used to pay for qualified education expenses. Qualifying U.S. Savings Bonds are Series EE bonds issued after 1989 and Series I bonds. The bond owner must be at least 24 years old before the bond's issues date (not the purchase date).

Eligible Education Expenses

Eligible expenses cover tuition and mandatory fees.

MAGI and Phaseout Limits

There are no phaseout limits on education savings bonds.

Uniform Gift to Minors Act/Uniform Transfer to Minors Act

The (Uniform Gift to Minors Act) UGMA or (Uniform Transfer to Minors Act) UTMA are acts that many states have adopted to allow minors to own assets (like securities) without the need of an attorney to set up a special trust fund. Just like any other trust, a custodian (or trustee) is appointed and the assets are held in their name until the beneficiary reaches the age of majority (between 18 and 21 in most states).



Guides

Article Categories