Life Support - Tax Facts
Tax Savvy Ways to Save for an Education
A Tax Fact from The Tax Institute at H&R Block
If you're waiting to start saving for your child's education - start now, don't wait.
Besides the fact that it's never too early to begin stashing away money for a college education, the here-and-now is a great time to take hold of some of the tax benefits that can go along with your saving efforts.
Two of the most tax-savvy ways to save for your kid's future can be found in Coverdell Education Savings Accounts, or ESAs, and Qualified Tuition Plans, known as QTPs or 529 plans.
The main attraction for these programs is the same that draws you to your qualified retirement account: distributions from ESAs and QTPs are tax-free when withdrawn and used for your child's education. That's right, tax-free.
There are several rules related to ESAs and QTPs that translate into both increased savings and more options:
There isn't one way of saving that is, hands down, better than the other. As a rule, education savings should be invested - you'll earn a better return when compared to the fairly low interest rates offered by bank savings accounts. But the "right" investment mix depends on the length of time until the beneficiary goes to college.
The advantage of compounding and non-taxable distributions offered by QTPs and ESAs can make a difference. For example, did you know that if you save $2,000 a year (at 5%) when your child is an infant, you'll have about $59,000 when he or she starts to college? But if you wait until your child is ready for high school, you'd need to save over $13,000 a year just to get the same result. And, many states offer a deduction or credit for residents who contribute to that state's QTP. (For more information on QTPs, visit http://www.savingforcollege.com.)
Important: If you use ESA or QTP funds for something other than qualified higher education expenses, the earnings part of the distribution is taxable to the beneficiary.
If you're planning to apply for need-based loans, grants, or scholarships, "how" you save can be just as important as "how much" you save. You should be aware that distributions from prepaid tuition plans, offered in QTPs, may count as the student's income, which may reduce or eliminate financial aid. The same goes for ESAs. They may also count as the student's assets on financial aid applications.
The right choice for you might actually be a combination of two (or more) of the available savings methods. You should investigate the options (and the financial aid consequences), and choose the method(s) that will help you reach your savings goal for your child's education. The best advice is to talk to your tax and financial advisor. And, remember, those college days will be here before you know it.
This Tax Fact is brought to you by The Tax Institute at H&R Block.
To view other helpful tax information or listen to our Tax Fact podcasts, visit www.digits.hrblock.com
As always...everyone's tax situation is different, so be sure to consult a tax professional or financial advisor before making important financial decisions.
This Tax Fact is for educational purposes only and is not intended to be a substitute for seeking personalized, professional advice, nor is it intended to be used to avoid IRS penalties.
A Tax Fact from The Tax Institute at H&R Block
If you're waiting to start saving for your child's education - start now, don't wait.
Besides the fact that it's never too early to begin stashing away money for a college education, the here-and-now is a great time to take hold of some of the tax benefits that can go along with your saving efforts.
Two of the most tax-savvy ways to save for your kid's future can be found in Coverdell Education Savings Accounts, or ESAs, and Qualified Tuition Plans, known as QTPs or 529 plans.
The main attraction for these programs is the same that draws you to your qualified retirement account: distributions from ESAs and QTPs are tax-free when withdrawn and used for your child's education. That's right, tax-free.
There are several rules related to ESAs and QTPs that translate into both increased savings and more options:
- The contribution limit for Coverdell ESAs is $2,000 a year. You can contribute even more - often much more - to QTPs.
- You can contribute to both an ESA and a QTP within the same year.
- QTPs offer many investment choices, and if you aren't crazy about the fund you're in, you can roll the funds into a different fund once in any 12-month period.
- Private and religious institutions can establish QTPs, expanding your choices of prepaid tuition plans.
The advantage of compounding and non-taxable distributions offered by QTPs and ESAs can make a difference. For example, did you know that if you save $2,000 a year (at 5%) when your child is an infant, you'll have about $59,000 when he or she starts to college? But if you wait until your child is ready for high school, you'd need to save over $13,000 a year just to get the same result. And, many states offer a deduction or credit for residents who contribute to that state's QTP. (For more information on QTPs, visit http://www.savingforcollege.com.)
Important: If you use ESA or QTP funds for something other than qualified higher education expenses, the earnings part of the distribution is taxable to the beneficiary.
If you're planning to apply for need-based loans, grants, or scholarships, "how" you save can be just as important as "how much" you save. You should be aware that distributions from prepaid tuition plans, offered in QTPs, may count as the student's income, which may reduce or eliminate financial aid. The same goes for ESAs. They may also count as the student's assets on financial aid applications.
The right choice for you might actually be a combination of two (or more) of the available savings methods. You should investigate the options (and the financial aid consequences), and choose the method(s) that will help you reach your savings goal for your child's education. The best advice is to talk to your tax and financial advisor. And, remember, those college days will be here before you know it.
This Tax Fact is brought to you by The Tax Institute at H&R Block.
To view other helpful tax information or listen to our Tax Fact podcasts, visit www.digits.hrblock.com
As always...everyone's tax situation is different, so be sure to consult a tax professional or financial advisor before making important financial decisions.
This Tax Fact is for educational purposes only and is not intended to be a substitute for seeking personalized, professional advice, nor is it intended to be used to avoid IRS penalties.
