By Cristina Wiebelt-Smith, CPA, Associate Wealth Advisor
The last time I wrote about college education savings ideas, my daughter had just returned to school after Christmas and we had a break from paying tuition in November and December. Well, her spring break just ended, we put her back on a plane to finish her last semester and we started paying tuition again.
I thought this would be a good time to come back with Part 2 of education planning once someone is in college. If you think this doesn’t apply to your family, remember that some tax credits can be used for trade school and they apply for yourself, your spouse and other dependents, not just children.
Fill out the Free Application for Federal Student Aid (FAFSA) each year, even if you don’t think you will qualify for financial aid. The process opens in November, so be ready to apply right away – some of the money is first-come, first-served, and it can affect work study opportunities. Keep a folder or easy access to your prior two years of tax returns, most recent paystubs, business tax returns, latest bank statements, investment statements, college account statements, mortgage information, debt balances and any other documentation that has a financial impact on your family.
Continue to look for scholarships while your child is in college. Students get caught up in applying during junior and senior year of high school, but they can continue to apply for scholarships while they’re in college as well.
Part of many financial aid packages is an on-campus job. Our daughter has a job in the costume shop working six hours a week; her school limits the number of hours students can work at on-campus jobs so they stay focused on their classes. This has given her enough spending money for incidentals, entertainment and even Ubers to and from the airport. Good news for us – we haven’t had to send any spending money to her! Don’t be afraid to let them work a few hours a week.
Don’t panic from sticker shock for HYPSM schools. When families hear Harvard or Stanford, the sticker shock hits hard and it can deter them from pursuing it any further, but don’t let this stop you. If your student is accepted at one of these schools, most of them make up the difference between the cost of tuition and your expected financial contribution. Private schools often have big endowments – which means big financial aid – and the costs may end up less than a state school.
There are additional financial considerations if your student is going out of state. Travel is the biggest – airline tickets, transportation to and from the airport if they don’t have a vehicle at school and food at the airport are all additional costs for which you should budget.
Tax Credits for Educational Expenses
There are two credits to consider if you are paying educational expenses. Credits are great tax savings because they offset your tax dollar for dollar. The credits have different income limitations, so have your tax preparer see if you qualify.
The American Opportunity Credit (AOTC) is the largest education tax credit available.
- For 2022, you can get a credit of up to $2,500 for the cost of tuition, fees and course materials during the first four years of a student’s college education or certificate program.
- The student must be enrolled at least half-time in a program leading to a degree, certificate or other recognized education credential.
- The credit is claimed on Form 8863 and is 20% of the first $10,000 and then 25% of the next $2,000. You need at least $12,000 of out-of-pocket expenses to get the full $2,500 credit.
The Lifetime Learning Credit is similar to the AOTC, with a few key differences.
- You do not need to pursue a degree to be eligible.
- The credit can be claimed for tuition, required fees and course materials for college or another technical training to learn or improve job skills.
- There is no limit on the number of years for which you can claim this credit.
- The Lifetime credit has an annual maximum of $2,000 per eligible student and cannot be claimed in the same year as the AOTC.
- The credit is also claimed on Form 8863 and is 20% of the first $10,000 of eligible expenses.
You can claim the credits in the same year that you take a tax-free distribution from a 529 plan or Coverdell ESA, with one caveat – the expenses you pay with 529 withdrawals cannot also be the expenses you use to qualify for an education credit. For example, if you paid $10,000 for tuition and used a $5,000 529 withdrawal, only $5,000 of tuition is available to calculate the credits. Planning around this is crucial to be eligible for the AOTC or Lifetime credit.
Both credits are per student, not per family, so if you have two in college at the same time, you can claim credits for both students. Plan ahead each year to take full advantage of the AOTC during the first four years, and then move to the Lifetime Learning Credit.
Prepare for when your child claims themselves on their own tax return, because your child has to be your dependent for you to take the credit. If the student files on their own and is not your dependent, they are eligible for the credit on their own tax return. See which way makes more sense for both of you.
Be realistic about what will work for your family along with your student’s wants and wishes. Set expectations early on about how much you can contribute to expenses, which expenses you are willing to fund and how spending money will work. Most families set a dollar amount and deposit it into the student’s bank account each month. Communication is the key here.
Investors should also consider whether the investor’s or beneficiary’s home state offers any state tax or other benefits available only from that state’s 529 Plan. Any state-based benefit should be one of many appropriately weighed factors in making an investment decision. The investor should consult their financial or tax advisor before investment in any state’s 529 Plan.
This piece is not intended to provide specific legal, tax, or other professional advice. For a comprehensive review of your personal situation, always consult with a tax or legal advisor.
