Get Schooled on Taxes & Education

in Financial Planning by

Some parts of this blog were updated on March 14, 2018

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.

Education Savings With a 529 Plan

Since they were first established in 1996, Section 529 college savings plans have become a popular tool used by parents to save for future college expenses. Now with tax reform, 529 plan funds can be used for qualifying elementary or high school expenses, as well as college expenses.

One reason 529 plans are so popular is the tax breaks they allow. As long as funds are used to pay for qualified education expenses, earnings within the account grow tax free. Also, many states allow full or partial deductions for 529 plan contributions. The amount invested in a 529 plan grows free of federal income taxes and, depending on where you live and what plan you choose, can provide a state tax write-off too.

Tax Incentives for College Students

If you or your dependent(s) are working toward a college degree, you can receive an annual tax credit of up to $2,500 per eligible student for the first four years of higher education through the American Opportunity Tax Credit. Even if you are simply taking a class or two to improve job skills, you may qualify for a credit of up to $2,000 per tax return through the Lifetime Learning Credit. There is no limit on the number of years you can claim the Lifetime Learning Credit, but there’s no double dipping. You can only choose one type of education tax credit per year. These credits phase out based on your level of income – check with the IRS for the latest information.

Our Take

It’s important to prioritize your own retirement over paying for education – you can likely get a student loan, 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.

Learn more about taxes and how they fit into your holistic financial life by reading our free Personal Capital Tax Guide for Holistic Financial Planning.

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This blog is for informational purposes only and is intended to offer guidance; not specific legal or tax advice. Clients are advised to consult their personal estate attorney and CPA before taking action based on this advice.

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Amin Dabit, CFP®

Amin Dabit, CFP®

Amin Dabit is the Director of Advisor Services with Personal Capital. Along with the EVP of Advisory, 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.
Amin Dabit, CFP®

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One Response

  1. Jeff

    Hey, Amin. Always great to read solid financial resources for students and parents as they approach their time in college. In addition to the 529, 401(k), and IRA options there are many states that still offer prepaid college tuition programs. Many have unique acronyms like GET, VPEP, and MET but the benefits may prove beneficial to families. Several programs allow students/parents to make tax-free withdrawals for qualified college expenses which can be substantive. Like most investing, starting early is the key but with prepaid college tuition programs make sure to read the fine print as some states guarantee their plans while others do not. The other consideration is whether or not your student will attend a qualifying university or college in a specific state. If so, this could be a great option; otherwise, a 529 may be a better choice given the fact it has a greater degree flexibility for students and parents.


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