The first thing to know about saving for college is that it’s never too early to start. The earlier you start saving (and investing) for your child’s future, the more time and flexibility you allow yourself.
Saving for college can be difficult for parents to do on top of saving for retirement and meeting all of the day-to-day cash flow needs. For most families, taking on student loans is likely in some regard. And that is okay, student loans are considered a “good debt” in most instances. They can also be a good way for your children to start building credit and learn the important lessons of principal and interest payments.
But what else should you know about saving for college? In this post, we’re going to cover the basic tax implications and discuss what we feel is the best way for parents to put money away for their children’s future education.
What Should I Know About Saving for College?
What School Expenses Qualify for Tax Credits?
If you’re helping your child fund their education, the IRS offers education credits. These can be claimed for qualified expenses paid with cash, check, credit card, debit card or with loan money.
These qualified expenses include:
- Related expenses required for enrollment or attendance
- Expenses covered by the American Opportunity Tax Credit (AOTC)
Bear in mind, there are income limitation phase outs for these qualified expenses so be sure to check that you meet the requirements.
For those who qualify, the AOTC offers up to a $2,500 credit on items assigned for study, such as:
What Expenses Aren’t Qualified?
The following items are not qualified, even in situations where you’re paying the school directly for them:
- Room and board
- Medical expenses/student health fees
- Personal, living or family expenses (such as meals)
As you consider how you’ll cover the costs of college, starting with tax-focused saving strategies can help.
Offered by states and some educational institutions, these plans allow you to save up to $15,000 per year for your child’s college costs without having to file an IRS gift tax return. Each state has their own plan. You DO NOT have to use the plan of the state in which you live.
529s can be used for books, supplies, equipment, room and board, and even computers or tablets and education software.
If your child doesn’t want to go to college, you can change the beneficiary to another child in your family. You can even roll over distributions from a 529 plan into another 529 plan established for the same beneficiary (or another family member) without tax consequences.
Grandparents can also start a 529 plan or other college savings vehicle. In fact, anyone can set up a 529 plan on behalf of anyone. You can even establish one for yourself.
529 accounts are great, because some of them even have age-based investment choices. You just choose the year your child will likely be starting college and the investments adjust based on that.
Generally, the investments will be more “aggressive” the more time there is until the money will be needed. And as your young one approaches college age, the investment will become more “conservative”. They work similarly to target date funds in your 401(k), or retirement account. This is a great “hands off” approach.
As your child moves through higher education it is important to keep in mind the financial implications. They will (likely) be graduating with some debt, so it is important to prepare them for that.
But it’s also important for you (the parents) to take advantage of some of the tax, and tax advantaged savings opportunities while you still can. 529 accounts are a great way to sock tax advantaged money away for college. As they say, time moves fast. So the earlier you can start putting this money away the better.
Please note we are not tax preparers, so consult with your tax professional or the IRS before claiming any expenses.