As high school graduation season nears, many families will be facing the financial reality of paying for the high cost of college tuition, fees, materials, and housing. For many, there will be no getting around the high costs of higher education, but how the costs are funded can create a more favorable outcome.
The decision on how to fund college should start with a tax review. There are a number of favorable tax credits, including the very generous American Opportunity Tax Credit, that can yield big tax benefits. To claim this credit a taxpayer must meet the income limits and pay the first $4,000 of college expenses out of pocket. If these requirements are met a taxpayer can claim a tax credit (a dollar-for-dollar reduction in the federal income taxes owed) of up to $2,500. This amount can be claimed in each of the first four years of higher education per child.
Next, college savings accounts such as 529 savings accounts, can be the next best source of funds. These accounts allow family members to save for a child’s education expenses. In some states the taxpayer may even be able to claim a small tax refund for any contributions made to a qualifying account. But the real benefit is that the investments in a 529 college savings account grow tax deferred and will be tax-free if the money is used to pay higher education expenses.
Finally, retirement plans, such as traditional and Roth IRAs, may be accessed penalty free to pay for the higher education expenses of a dependent. This may provide access to needed funds, which in the case of a Roth IRA, may also be tax free up to the amount of the contributions made to the account, whereas the earnings on those contributions will continue to grow tax free.