If you are a parent with young children, it is never too early to begin to save for the high cost of a college education. Here are two popular tax-favored programs you can consider. Keep in mind that the earlier you begin to participate in these programs, the greater the amount that will be available for tuition.
Qualified Tuition Program (QTP). A qualified tuition program (also known as a 529 plan for the section of the Tax Code that governs them) may be a state plan or a private plan. A state plan is a program established and maintained by a state that allows taxpayers to contribute to an account for paying a student’s qualified higher education expenses. Similarly, private plans, provided by colleges and groups of colleges allow taxpayers to contribute a student’s qualified education expenses. These 529 plans have, in recent years, become a popular way for parents and other family members to save for a child’s college education.
529 plan distributions are tax-free as long as they are used to pay qualified higher education expenses for a designated beneficiary. Qualified expenses include tuition, required fees, books and supplies. For someone who is at least a half-time student, room and board also qualifies as higher education expense.
Though contributions to 529 plans are not deductible for federal income tax purposes, they are deductible for PA personal income tax. Be sure to read our May 2, 2017 blog regarding PA 529 plan contributions and its restrictions on tax deductions. In addition, PA is considering restricting the tax deductibility of 529 contributions to PA plans only. (The current rules allow tax deductions for contributions made to out-of-state plans).
Coverdell education savings accounts. Coverdell education savings are custodial accounts similar to IRAs. Funds in a Coverdell ESA can be used for K-12 and related expenses, as well as higher education expense. The maximum annual Coverdell ESA contribution is limited to $2,000 per beneficiary, regardless of the number of contributors. Excess contributions are subject to an excise tax.
Entities such as corporations, partnerships, and trusts, as well as individuals can contribute to one or several ESAs. However, contributions by individual taxpayers are subject to phase-out depending on their adjusted gross income. The annual contribution starts to phase out for married couples filing jointly with modified AGI at or above $190,000 and less than $220,000 and at or above $95,000 and less than $110,000 for single individuals.
Contributions are not deductible by the donor and distributions are not included in the beneficiary’s income as long as they are used to pay for qualified education expenses. Earnings accumulate tax-free. Contributions generally must stop when the beneficiary turns age 18, except for individuals with special needs. Parents can maximize benefits, however, by transferring the older siblings’ account balance to a younger brother, sister or first cousin, thereby extending the tax-free growth period.
In addition to the above two plans, other ways to save for a college education include: [Read more…] about Planning for College Tuition