The Ultimate Guide to Tax Savings for Education
4 min read
February 26, 2016 • Block Advisors
According to U.S. News and World Report, the average cost of tuition and fees for the 2019 to 2020 school year was $36,801 at private colleges, $10,116 for state residents at public colleges and $22,577 for out-of-state students at state schools. Beyond this, the College Board’s 2018 Trends in College Pricing Report, reports that cost has tripled for public four-year schools and doubled at public two-year and private non-profit four-year school between 1988 and 2018.
With tuition on the rise each year, many parents choose to plan ahead to save for their dependent’s college education. Education savings plans provide not only an opportunity to save money for education but also potential tax savings.
So this begs the question: “Is it difficult to navigate through the vast amount of potential tax savings for education?”
Luckily, there are a variety of education savings plans that can also tax savings on your tax return. 529 Plans, Coverdell Education Savings Accounts (ESAs), Educational Savings Bonds, and penalty-free IRA Distributions are a few of them. Here are the considerations of each type of tax savings for education and how it will potentially affect your overall tax forecast:
529 Plans: Qualified Tuition Programs
A 529 plan, or Qualified Tuition Program, is a type of savings program where individuals can prepay or save for qualified higher education expenses at eligible educational institutions. Many people enroll and participate in 529 plans for their children or grandchildren for a variety of reasons:
- The earnings on your contributions grow tax-free. When they are distributed for eligible educational expenses, the earnings are excluded from the student’s taxable income.
- Some states allow contributions to these plans to be excluded from the adjusted gross income for calculating your state tax bill or allow a tax deduction for contributions.
- Grandparents can transfer substantial amounts to their grandchildren’s 529 plans without paying gift tax. This is a great tool, but it requires some financial planning to maximize the tax benefit.
- Qualified expenses include tuition, fees, room and board, and equipment.
- New under the TCJA, qualified expenses now include tuition for grades K-12. Caution: not all states allow qualified distributions for K-12. Check your state’s rules.
Are 529s Tax Deductible?
Earnings from 529 plans are not subject to federal tax and generally not subject to state tax when used for qualified education expenses such as tuition, fees, books, as well as room and board. The contributions made to the 529 plan, however, are not tax deductible on your federal return.
Coverdell Education Savings Accounts
A Coverdell Education Savings Account (Coverdell ESA) is a trust or custodial account created solely to pay for qualified education expenses for a designated beneficiary. When the account is established, the beneficiary must be under 18 years old or a special needs beneficiary. This type of account is attractive for many because distributions for qualified expenses are tax-free. Non-qualified distributions are partly taxable and subject to penalty.
Coverdell ESAs cover the cost of qualified higher education and qualifying elementary and secondary education institutions as well. Qualified expenses are similar to the qualified 529 plan expenses.
While the benefits of Coverdell ESAs are similar to 529 plans, there are some differences:
- The account is opened at a brokerage firm or bank, rather than through your state’s 529 programs.
- Contributions to each beneficiary are limited to $2,000 per year, even if there are multiple ESAs for a beneficiary. You can contribute for the previous tax year until the filing deadline, which is typically on Tax Day.
- There are limitations on how much one can contribute based on adjusted gross income. Any excess contributions are subject to a 6 percent additional tax.
- If the ESA beneficiary reaches 30 years old, the account must be distributed. However, it can be rolled over for the benefit of certain family members.
Are Coverdell ESAs Tax Deductible?
Coverdell ESA contributions are not tax deductible, but, similar to some individual retirement accounts, your account grows tax-free until withdrawn. Withdrawals from Coverdell ESAs are typically tax-free to the extent that the amount of the withdrawal is not more than the beneficiary’s qualified education expenses.
Education Savings Bond Program
The Education Savings Bond Program permits qualified taxpayers to exclude from their gross income all or a portion of the interest earned on the redemption of qualified U.S. savings bonds. A qualified bond is a Series EE bond issued after 1989 or a Series I bond.
If the requirements are met, the bond interest is not taxable when redeemed. To qualify for this exclusion, you must:
- Pay qualified education expenses for the taxpayer, the taxpayer’s spouse, or the taxpayer’s dependent.
- Be eligible based on modified adjusted gross income. Otherwise, you could be affected by a partial or complete phase-out.
- Not file as married filing separately. The bond must be issued in your name or in the name of yourself and your spouse (as co-owners).
- Be at least 24 years old before the bond’s issue date.
Are Education Savings Bonds Taxable?
Cashed-out bonds that exceed qualified educational expenses are taxable.
Not Sure What Avenue to Pursue? Connect with Experts to Find Additional Tax Savings for Education
Our tax experts at Block Advisors can help make informed decisions about how tax credits and deductions factor into your tax return, as well as your overall financial picture. Find your advisor match now.