Tackling College Costs at the Eleventh Hour

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We’ve been asked, “My daughter is going to college next year, and I haven’t saved a dime. What can I do?” I know that story is not funny, but it is sadly close to the truth for many. The best way to climb the mountain of college costs is gradually, but if you need to make some last minute leaps, our government has a few tax-related strategies.

The government offers significant tax credits and tax deductions to help with college costs. If you meet certain income criteria, the available tax breaks for educational expenses could save you a year’s worth of tuition. And even if you are financially well-off, there are strategies to help you trim costs.

Take your tax credit . For most Americans, the Hope Credit and Lifetime Learning Credit are tax-savvy ways to save extra dollars that would otherwise go to the IRS.

The Hope tax credit saves you up to $1,500 per year for the first two years of enrollment at a post-secondary school. You will receive a tax credit dollar for dollar on the first $1,000 spent on qualified higher education and 50 cents on the dollar for the next $1,000. You may take the Hope Scholarship credit for each college freshman or sophomore you have in college.

The Lifetime Learning credit provides a tax credit of 20% for up to $10,000 spent on tuition, fees, and books. Although the Lifetime credit can be taken for an unlimited number of years, you may not deduct more than $2,000 per tax return. Even if you have two or more members of your family in college, you will not be able to deduct more than $2,000 per year.

To see the tax credit savings, let’s consider the Hoo family . The Hoos plan to pay their son Wahoo’s tuition of $5,000 per year for four years. To maximize their savings, they will take the Hope Scholarship for the first two years, reducing their taxes by $3,000. The following years, they will take the Lifetime Learning credit which will save them another $2,500. Over five tax years, they will save a total of $5,500, equivalent to one year’s tuition payment.

Both of these tax credit benefits are phased-out for earnings between $42,000-$52,000 ($85,000 and $105,000 for couples filing jointly). Education tax credits can be taken for you, your spouse or any dependent enrolled in school. However, you may not take both tax credits for the same person.

In some cases, parents who do not qualify for the education credits may forgo claiming an eligible dependent. The student may then claim the education credits on his or her own return.

Take a tuition tax deduction . If you do not qualify for the Hope or Lifetime Learning credit, you may still be eligible for a tuition and fees deduction of up to $4,000. This benefit is phased out between $65,000 and $80,000 ($130,000 and $160,000 for couples filing jointly).

The difference between a tax credit and a tax deduction is an important one. Tax credits come straight off the top of what you owe the IRS, dollar for dollar. Tax deductions simply reduce the amount of income that will be taxed.

Gift appreciated stock . If you plan on selling stock to pay for college expenses, reduce Uncle Sam’s cut on earnings by gifting the stock to your child. Selling appreciated stock will cost you 15% in capital gains. Instead, use your child’s lower tax bracket to your advantage. Your children can sell the stock at 5% — a 10% savings.

However, only parents who do not qualify for financial aid should pursue this option. If you qualify for financial aid, moving assets into your child’s name may be a bad idea because the student’s assets are assessed at a higher rate. Tax savings gained by gifting appreciated stock will not make up for your loss in financial aid eligibility.

Cash in US treasury bonds . If you hold series EE or I bonds, you can receive tax-free interest on your investment. Earnings are tax-free if the bond is used to pay for tuition and fees. This benefit does not apply to room and board costs or to students who are not seeking a degree.

Deduct loan interest . If you are paying interest on a student loan for you, your spouse or a dependent, the interest is tax deductible. We usually do not recommend borrowing money. However, mortgages and student loans are the exception. The benefits to you in the long-run will outweigh the costs.

However, don’t borrow or withdraw money from your IRA. If you must make a choice between saving for retirement and paying for college, pick retirement. The government will loan you money for college, but not for retirement. While you can borrow from your IRA for college without triggering the 10% early withdrawal penalty, your lost earnings won’t justify such a move.

Each family is unique. Some can reduce their college expenses through government credits and deductions, others by gifting appreciated stock and not selling certain bonds. The right strategy for your family will depend on how many children you have in school, how long they have been in school, college costs, and your earnings. You may want to consider the services of a smart financial planner to help you maximize the savings available.

Photo by Juan Ramos on Unsplash


See also:
  1. College Savings Part 1 – A College Degree is Worth a Million Bucks
  2. College Savings Part 2 – Start College Savings the Day They Are Born
  3. College Savings Part 3 – Joshua and the Wall of College Savings
  4. College Savings Part 4 – 529 Plans: What’s Important?
  5. College Savings Part 5 – Prepaid Tuition Programs May Be Fool’s Gold
  6. College Savings Part 6 – Tackling college costs at the eleventh hour
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David John Marotta is the Founder and President of Marotta Wealth Management. He played for the State Department chess team at age 11, graduated from Stanford, taught Computer and Information Science, and still loves math and strategy games. Favorite number: e (2.7182818...)

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Beth Nedelisky is part of the Investment Committee at Marotta Wealth Management and specializes in trust and endowment management. Born in Africa, raised in Europe and married in the USA, Beth understands world markets first hand.