Saving for your child’s college can be more difficult than saving for retirement. The clock starts ticking the day your child is born, and as college approaches, the less risk you can afford to take. Consider these tax-advantaged tools:
· Coverdell Education Savings Accounts (“ESA”) allow you to save up to $ 2,000 per year per student. Earnings are tax-deferred and withdrawals are tax-free for education costs.
· Section 529 Plans they are state sponsored college savings plans. Each state sets its own lifetime contribution limit, which ranges from $ 100,000 to $ 300,000 +. Traditional “prepaid tuition” plans cover specific units of tuition, such as a credit hour or a course. The newer “college savings” plans invest contributions into mutual funds for potentially greater growth, usually adjusting portfolios of stocks to bonds and cash as your child ages. You can choose the plan from any state; however, some states offer deductions for contributions to their own plans.
· US Savings Bonds allows you to defer income tax until you redeem the voucher. Interest on series EE savings bonds issued after 1989 to people 24 and older may be tax-free if you use them the year you redeem the bond for “qualified educational costs” (tuition and fees minus free scholarships status, qualified state tuition plan benefits and costs for which you claim the American Opportunity or Lifetime Learning credit). For 2015, the exclusion will be removed for households with “modified AGI” of $ 77,200-92,200 (singles and heads of household) or $ 115,750-145,750 (joint taxpayers) and is not available for married couples filing separately.
Other limits for ESA plans and 529 plans
Coverdell ESA
$ 110,000 gross donor income limit ($ 220,000 combined)
Contribution limit $ 2,000 per year
Tax-free withdrawals for elementary, high school, and college costs, including reasonable room and board. Expenses paid with ESA accounts do not qualify for American Opportunity or Lifetime Learning credits. Withdrawals not used for education are taxed as ordinary income.
You must use the assets before age 30, otherwise pay income taxes or enter another family member’s ESA.
Plan 529
$ 115,000-315,000 lifetime contribution limit
Retreats
Tax-free for “qualified higher education expenses.” Withdrawals not used for college are taxed only if they exceed contributions.
You can designate a new beneficiary if the child decides not to attend college.
Section 529 plans offer estate tax exemptions in addition to income tax exemptions: contributions are considered entire gifts for gift tax purposes; You can contribute up to $ 14,000 per year per student, or $ 28,000 jointly with your spouse, without the effect of gift tax; The 5-year accumulation plan establishes that you can give a beneficiary up to $ 80,000 in a single year, or $ 160,000 jointly with your spouse, as long as you do not give more during the next four years; Plan assets are not included in your taxable estate unless you “advance contributions” in a single year and then die before the end of that period.
Also, if you lose money on a 529 plan, you can close your account and deduct the loss as a miscellaneous itemized deduction. You can also transfer accounts from one plan to another, but only once a year. If you’re saving for college and have permanent life insurance, you can put savings dollars into your policy and bring tax-free cash for college (or anything else). If you later relinquish the policy, any earnings that exceed your total premiums are taxed as ordinary income when you relinquish the policy (suggest that you can still take out all of your money without relinquishing the policy).
American Opportunities / Lifetime Learning Credits
These credits are available to parents (if they claim a student as a dependent) or students (if they cannot be claimed as someone else’s dependent). These are the rules:
You, your spouse, or your dependent enrolled at least part-time in the first four years of postsecondary education.
1) Any year of post-secondary or graduate education
2) Any course of instruction at an eligible institution to acquire or enhance job skills
Eligible expenses
100% of the first $ 2,000 in expenses plus 25% of the next $ 2,000 in expenses; $ 2,500 maximum per student
20% of the first $ 10,000 in expenses; $ 2,000 annual maximum per taxpayer
You can claim the full American Opportunity credit for as many students as they qualify; however, the Lifetime Learning Credit is capped at $ 2,000 per taxpayer per year.
The American Opportunity credit is phased out as your adjusted gross income exceeds $ 80,000 ($ 160,000 for joint taxpayers) (2015). The Lifetime Learning credit is phased out as your adjusted gross income exceeds $ 55,000 ($ 110,000 combined) (2015).
You cannot claim credits for expenses you pay from an Education Savings Account or Section 529 Plan established for that student.
Married couples filing a separate return cannot claim the credits.
Give your child cherished assets to pay for college costs
Previously, it was possible to award appreciated assets to students aged 18 and over. prior to You sold them to pay for college expenses. Your child’s tax on those earnings will likely be less than yours. And this measure kept his adjusted gross income low, preserving his adjustments to income, deductions and credits. You can give each child up to $ 14,000 per year ($ 28,000 per couple) with no gift tax consequences (2015). However, since 2008, the “child tax” rules now apply to full-time students under the age of 24, greatly limiting this strategy.
You can withdraw funds from your IRA or qualified plan for college costs (tuition, room and board, books, and fees) without the usual 10% penalty for withdrawals before age 59½. Tax breaks for parents and students are generally eliminated as the parents’ adjusted gross income increases and financial aid is based on family income and assets. Emancipating your child cuts that financial cord and allows you to qualify for tax exemptions and financial aid based on your own income and assets. Your child will have to provide more than half of his own support (from investment and earned income) in order for him to no longer qualify as your dependent. This, in turn, allows them to claim their own personal exemption (which can be phased out on your return anyway).
If dorm life doesn’t suit your student, consider buying him a home off campus. As long as you can trust that they won’t trash the place, they will get some financial education and responsibility in the real world along with their college courses. This offers several tax and financial advantages:
You can treat it like a second home and deduct the mortgage interest and property taxes you pay on Schedule A. Or you can treat it like a rental property, collect rent, and report rental income and expenses on Schedule E.
You can pay your child an administration fee and tax-advantaged employee benefits to manage the property.
You can title the house in your child’s name (or together with him) and include him as a co-signer on the mortgage to help build your credit.
A child who owns and occupies the home for two years can exclude up to $ 250,000 of earnings from his income when he finally sells.
Traditional tax planning seeks to minimize the tax period. But some tax strategies actually cost you when it comes time to apply for college financial aid based on your needs. Therefore, it is important to know how your tax choices affect the Free Application for Federal Student Aid (“FAFSA”) that schools use to assess financial need.
All schools use a “federal methodology” to calculate how much federal aid they can spend. Some schools also use an “institutional methodology” to calculate their own aid. Both methodologies work as follows:
The student’s “taxable income”, less taxes and an “income protection allowance” times fifty%
+ The student’s “assessable assets” times twenty%
+ Parents’ “taxable income”, less taxes and a living allowance times 22% to 47% (based on income)
+ The “assessable assets” of the parents, less an “asset protection allowance” (based on the age of the older parent) times 5.6%
= Expected Family Contribution (“EFC”)
“Cost of attendance” minus EFC equals “financial need.” The key, then, is to minimize income and assessable assets until after the latest FAFSA reporting period. These are the key points to consider:
Taxable assets generally include cash, checking and savings accounts, discretionary securities and investment accounts, and the net worth of the vacation home, but not the balances of retirement accounts or qualified plans, the net worth of the home or the personal assets. Some schools that use the “institutional methodology” also include life insurance and annuity cash values, home equity, family farm equity, and siblings’ assets.
Taxable income includes AGI (adjusted gross income) More various “tax-free income and benefits” such as:
o Earned income and child tax credits
or tax-free interest income
or child support received
o Contributions to the IRA and retirement plan (be careful when making contributions before your child enters college, as they are considered “available” to pay for school)
or tax-free gain on the sale of your primary residence
or gifts of cash (but not owned) from friends and relatives (if grandparents or relatives want to give gifts, consider waiting until after the student’s last FAFSA is due, or even giving gifts after graduation to withdraw student loans)
o Some schools that use the “institutional methodology” also include flexible spending and contributions to health savings accounts.
College costs are high enough that even families with six-figure incomes can qualify for help based on their needs. So don’t assume your income automatically disqualifies you.
Decisions about college financial aid are based on income and assets from the previous year; In most cases, the “base year” begins on January 1 of the child’s junior year of high school. This means that it is best to start planning no later than the beginning of your child’s third year. FAFSA forms must be submitted annually whenever the student seeks help.
Taxable income does not include loan proceeds. This rule can make loans against life insurance, retirement or investment accounts, or your primary residence a suitable source of tuition funds.