Investing

Education Planning

Education Planning

Most parents want to save money for their children’s future whether it be for college, a wedding, or a first-time home purchase. Many options exist with different pluses and minuses. A variety of education savings accounts and tax credits are available to assist parents in saving for and paying for their children’s education costs.

Coverdell Education Savings Accounts

A Coverdell Education Savings Account (“CESA”) is an investment account established with nondeductible contributions of cash that offers tax benefits to individuals who wish to save money for a child’s or grandchild’s education expenses. Parents and other contributors can contribute up to $2,000 total combined annually for each beneficiary. The contributions grow tax free and are withdrawn tax free if they are used for qualified education expenses.

Qualified education expenses include tuition and mandatory fees at eligible education institutions, books, supplies and computer equipment for courses, room and board paid directly to the school IF the student is enrolled AT LEAST HALF TIME, and expenses for special-needs services for special needs students. Funds can be used for similar qualified expenses at private elementary and secondary schools.

The assets in a CESA must be withdrawn when the beneficiary reaches age 30. In this scenario, a 10% penalty would be required to be paid on the earnings portion of the withdrawal that is included in the withdrawal recipient’s taxable income. Additionally, the amount of earnings included in the taxable income would be subject to income taxes. These same rules would apply to any use of CESA funds for nonqualified expenses. To avoid this situation, the parent or responsible individual has the right to change the beneficiary to another family member at any time.

Section 529 Plans (aka Qualified Tuition Plans)

A 529 plan is similar to a CESA in that it offers tax benefits to parents and grandparents who wish to save for future education costs. 529 plans are sponsored by states, state agencies or educational institutions. States establish the individual contribution limits. Generally speaking, you wouldn’t want to exceed an annual contribution of $15,000 in order to avoid paying gift taxes. The contributions grow tax free and are withdrawn tax free if they are used for qualified education expenses.

Qualified education expenses are the same for a 529 plan as they are for a CESA. The earnings portion of any withdrawals used for nonqualified expenses are also subject to income taxes and a 10% penalty. Parents have the option to change the beneficiary on a 529 plan if the new beneficiary is a family member.

IRAs (Traditional, Roth, SEP and SIMPLE)

Did you know you can withdraw money from your IRA, without penalty, to pay for qualified higher education expenses? For undergraduate and graduate tuition and other fees, books and supplies and room and board if at least half time, you can withdraw funds from IRA without incurring the 10% early withdrawal penalty. If you are withdrawing from a Traditional, SiMPLE or SEP you will be required to pay taxes on the withdrawal. If pulling from a Roth, no tax payment will be required. Importantly, a qualified distribution from a Roth IRA must consist of funds that have been held in the Roth for at least five years.

Education Tax Credits

American Opportunity Tax Credit: For qualified tuition, enrollment fees, textbooks and materials in the first four years of postsecondary education for taxpayer, spouse or dependent, a credit of up to $2,500 can be taken on the taxpayer’s return.

Lifetime Learning Credit: For qualified tuition and related expenses, an annual credit up to $2,000 per year per family may be claimed. To claim the full $2,000 credit, the taxpayer must spend $10,000 annually on qualified expenses. The Lifetime Learning Credit can be claimed for an unlimited number of years.

Other education planning tools exist. Those mentioned above are among the most commonly used to plan for and to fund educations expenses.