Nontraditional Options for College Savings
The recent tax law change will increase the annual limit on contributions to an education IRA from the current $500 per year to $2,000 per year. Thank goodness! It was hardly worth the hassle of setting up one of these accounts for a measly $500 a year. With a $2,000 limit, however, you can reach, or get close to your college goal if you start saving as soon as your child is born.
As with all IRAs, the income and capital growth are deferred within an education IRA until the funds are withdrawn for college.
Education IRAs have income limits for the parents, but you can change the beneficiary designation to another child if your first child decides not to go to college. One of the problems with education IRAs is that you can only use the funds for your children, so if none of your children go to college, the funds become taxable to the last named beneficiary when they reach 30 years of age. Unfortunately, you can't roll the unused education IRA over into a personal IRA, the accumulated capital gain and income are taxed to the beneficiary.
Tax Credits for Parents of College Students
If you qualify (by attending a college or post-high school at least half time), you could use the HOPE credit for your child's freshman and sophomore years, and the Lifetime Learning Credit for her junior and senior years.
There are two tax credits that may be available to you during the time that your children are in college. As with so much of the income tax code, these tax credits are not cut and dried, but depend on your annual income and some other stipulations.
As you know, there are tax deductions and then there are tax credits. The difference is where they can be used on your tax return. A deduction is listed on Schedule A of your income tax return, and if your deductions are large enough to exceed your standard deduction, you can subtract the deductible sum from your adjusted gross income. After you've subtracted out your exemptions, this figure is called your taxable income and used to calculate your tax.
A tax credit is usually better because you don't have to itemize your deductions to use the credit. You can file your return using a standard deduction and still use a credit. Once you've calculated your tax, a credit is subtracted from this tax to lower what you owe the IRS.
The HOPE (Higher Opportunities for Performance in Education) credit has been available since 1998. It's a tax credit for qualified tuition and related expenses during a student's first two years of college. The student must attend college or other post-high school courses at least half time.
The credit is for 100 percent of the first $1,000 of qualified expenses paid during the year, plus 50 percent of the next $2,000, for a maximum of $3,000.
A Lifetime Learning Credit is a credit for expenses that don't qualify for the HOPE credit. The Lifetime Learning Credit is available for any school year for courses aimed at acquiring or improving job skills. The credit may be for undergraduate, graduate, or professional degree courses.
The Lifetime Learning Credit is equal to 2 percent of expenses up to $5,000, for a maximum credit of $1,000 per year. After the year 2003, the credit will rise to 20 percent of $10,000, for a maximum credit of $5,000 per year.
The Lifetime Learning Credit is for you, your spouse, and your children or other dependents. It's intended to be used for tuition and related fees—not room and board, commuting, or other expenses. And, of course, there are income limits.
What the IRS giveth, the IRS taketh away. The credit begins to phase out with adjusted gross income over $80,000 per year and is completely gone if your income is more than $100,000 per year (for married filers, the figures are halved for single filers). We're not talking about $80,000 in taxable income, we're talking adjusted gross income—the total of all your income, with some adjustments.
More on: Paying for College
Excerpted from The Complete Idiot's Guide to Personal Finance in Your 40s and 50s © 2002 by Sarah Young Fisher and Susan Shelly. All rights reserved including the right of reproduction in whole or in part in any form. Used by arrangement with Alpha Books, a member of Penguin Group (USA) Inc.
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