is there a college fund that can be used as a tax deduction? If so, which one will allow for the most?

Question

I make a 'decent' amount of money per year. I want to reduce the amount of money that I have to pay back to the IRS by investing in my daughters college education.

Answer 1

You can contribute to instruments that will grow tax-free toward education, but don't get a tax deduction for your contribution. Check out Coverdale accounts, 529 plans, and prepaid tuition credits in your state. See http://www.irs.gov/taxtopics/tc313.html for more info.

If she's already in college and is your dependent, you can take education tax credits for some of her tuition and fees if you qualify.

Answer 2

I'm, assuming that by decent you mean that you have a fair amount of discretionary income and not "fabulously wealthy".

529's are oversold!! Unless you are fabulously wealthy. There are so many "i's to dot and t's to cross" that they make NO SENSE for the middle class family. Coverdell Educ. IRAs have the same problem with a few less "cross i's".

For example, you get NO immediate tax deduction with either. The tax benefit applies only to the growth and then ONLY if the money is used for "qualifying education expenses." There are rules for each as to use of the money by other than the original beneficiary that you should look at before putting money into either type of plan because there are penalties for withdrawal for persons or reasons that are not "qualified".

There are trps too: both have annual limits based on beneficiaries, not contributors, so be sure that Grandparents/ Aunts & Uncles or others don't unknowingly trip you up.

Also, use of thes types of plans disqualify use of other eduacation benefits that migfht be more advantageous ( Hope & Lifetime Learning Credits, Tuition & Fees deduction).

Here is what I think is the best play to start with: a custodial account ( under your state's UTMA or UGMA laws). You ar the custodian itf ( in trust for) your daughter. She is the owner of the account but you are the decision maker for her benefit until she reaches majority. As a child the first $850 of investment income is not taxed and the next $850 is taxed at 10% (or 5% if LT capital gain.) Income above that is taxed at your tax rate while she is under 18 ( the kiddie tax).

Let's assume a growth rate of 8.5%. Until her account balance exceeds $10k she will not even have to file a tax return. After her income exceeds $850 in a year, she will still only pay a max of 10% on the amount over $850 up to $1700.

More realistically, let's say she is now 8 years old, ie 10 years till college. You invest $10000 in a blue-chip Exchange traded fund (no capital gain distributions) that pays dividends at a constant 5%, which are reinvested. During the 10 years dividends total $6289, so more than $850 was never received in any year, hence no tax was paid. Cost basis of her account is $16289. Suppose the inital $10k with re-invested dividends has grown to $28259, leaving a Long term capital gain of $12000 on which tax will be a maximum of $1800 (Fed).

Now, suppose she chooses not to go to college . You have made $18259 of profit and paid only $1800 in tax, less than 10%. She can usethis for travel, to buy a car, down paynment on a house, anything!!

If she does go to college, depending on your AGI, you can also take advantage of one of the Educ. incentives listed earlier and reduce the tax further. ( Worst case: T&F deduction of $500, best case Hope credit of $1650) This is all true whether she goes to the local community college,$2000 +/year or Stanford at $25000+/year.

Now, same scenario, but you put $10k into a $529 plan. It grows to the same $28259. If she goes to Stanford, you will get the full tax benefit of the plan. If she goes to Community College or not at all, you have the problem of finding an alternate beneficiary or eating the tax on the unused portion of the growth. Ditto Coverdell with slightly more alternate bene choices.

That's why I say that 529's & Coverdells are oversold... For the average middle class taxpayer custodial accounts give you far more flexibility for very little additional (if any) cost.
I think the place for the 529 & Coverdell is for money earmarked for education after the custodian account has been maximized.

Hank Roitman, EA
Sacramento, CA

Answer 3

I have not heard of a college fund that will help but you can get a education credit for paying tuition and fees. I f you want a break to help lower your income try investing in a traditional IRA. You can contribute up to 4,000 for you and if married 4,000 for your spouse. It is limited by income. Another way to lower your tax is to have more charitable contrubutions. That goes on your Sch. A. There are many tricks to the trade to lower your tax owed.

Brandy from Liberty Tax Service

Answer 4

Invest it in a 529 program. Not only can you deduct it from your income, but the capital gains are tax free if it is used 100% towards her education. My daughter is 3 and I contribute every month.