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Personal Capital Tax Series – 4: Get Schooled on Taxes & Education

March 15, 2017 in Financial Planning by

There’s no question about it: education is expensive. A recent survey found that a “moderate” college budget for a public school (in-state) averaged nearly $25,000 for the academic year. It’s never too early to start thinking about this important financial topic – and there are ways you can leverage education costs to lower your tax bill.

College Savings With a 529 Plan

A 529 plan is a state-sponsored plan used for saving toward a college education. This type of plan has the potential to lower your state tax bill in addition to your federal taxes, depending on where you live. From a federal tax perspective, the money in this account grows tax-free and can be used for college expenses beyond tuition, such as books, a computer and even room and board, with some restrictions.

You are even allowed to switch beneficiaries. This could come in handy if your original beneficiary decides to skip college. However, you’ll pay a 10% penalty tax and you’ll owe capital gains taxes if you use the money for non-higher education expenses.

Did you know you can also change the investment mix of a 529 plan by altering the beneficiary’s graduation date? This will change the growth rate of the plan’s assets depending on how aggressive or conservative you want your 529 plan to be. You’ll want to make sure that the mix is still appropriate for your circumstances. (You can use our free tools to track all your financial accounts, including a 529 plan.)

Tax Credits and Student Loan Payment

There are also a few other education expenses that can be leveraged in regards to taxes. For example, if you or your dependents are working toward a college degree, there’s a $2,500 tax credit you might be eligible for. Or you might check out the Lifetime Learning Credit if you’re honing some job-related skills. And if you are paying back your child’s student loans, there may be other viable tax deductions to consider.

Retirement First!

You should max out your retirement accounts first, even if your retirement picture looks bright, because generally the tax savings are better and the restrictions less onerous.

It’s important to prioritize your own retirement over paying for college – you can get a student loan for college, but no such loan exists for retirement. You should max out your retirement accounts first, even if your retirement picture looks bright, because generally the tax savings are better and the restrictions less onerous. For example, maxing out your 401k or IRA is more beneficial because the immediate tax deduction and the lengthy tax-deferred growth period are generally more advantageous than the tax-free growth associated with 529 plans. Likewise, if you’re eligible for a Roth IRA, max it out before establishing a 529 plan. Funds in a 529 plan can be pulled after the intended beneficiary turns 18, but there is a 10% penalty if the withdrawal does not fall under qualified education expenses. A Roth IRA offers more flexibility in how the funds are used.

If you are unsure whether your retirement savings are adequate, you can gain a clearer understanding of your entire financial picture through comprehensive, ongoing tracking with our free tools.

For more information about taxes and education, as well as other topics such as retirement, housing, and charitable gifting, download our free “Tax Guide for Holistic Financial Planning.”

This blog is for informational purposes only; we are not in the business of providing tax or legal advice and we generally recommend seeking the advice and counsel of a tax professional before taking any action that may cause a material taxable event.

Next Up: Annuities

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Amin Dabit, CFP®

Amin Dabit, CFP®

Amin Dabit is a Senior Vice President and Financial Planning Manager with Personal Capital. Along with the EVP of Portfolio Management, Amin helps lead Personal Capital’s financial planning experience and advice. Amin brings over a dozen years of experience in private wealth management and financial planning. Amin works with the advisory team to identify and establish strategies for reaching clients' financial goals by providing comprehensive, customized financial advice designed to improve their financial lives.

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