4 Tips for College Funding

Tip 1: Build Savings

Start a college savings fund as early as possible in your child’s life and continue contributing on a regular basis. There are several ways to get tax advantages while saving for college which will help offset some of the tuition costs. Consider these options:

• A 529 plan allows tax-free withdrawals from your savings to pay for qualified college costs (and up to $10,000 of qualified K–12 tuition each year). All 50 states and the District of Columbia offer some form of a 529 plan. Contribution limits vary by plan. You’re typically given a specific selection of investment fund options, much like the choices available in a 401(k) plan. Your contributions are not deductible on your federal income tax return, but some states allow a state tax deduction.
• A Coverdell Education Savings Account, or Coverdell ESA, is similar to many 529 plans. A Coverdell account allows tax-free withdrawals to pay for qualified college costs as well as qualified K–12 expenses. But unlike most 529 plans, a Coverdell lets you invest in basically any stocks, bonds or funds you choose. Your contributions are capped at $2,000 per beneficiary per year and are not deductible on either your federal or state income tax return.
• A custodial account can be set up in your child’s name. By having the account in your child’s name, you’re able to shift taxable earnings on the account to the child. Based on the “kiddie tax” rules, you can take advantage of the child’s lower tax rate on the first $2,200 of earnings. Any amount earned above $2,200 will be taxed at the income tax rates that apply to a trust. Depending on where you live, a custodial account is called either a Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA) account.
• Series EE and Series II US savings bonds earn interest that’s generally federal income tax-free if used to pay qualified higher education expenses. The tax break is limited or eliminated altogether for higher-income taxpayers.
• IRAs are mostly meant to give you tax advantages on retirement savings. But you can also use IRA assets to cover qualified higher education expenses — without owing the 10% penalty that normally applies to withdrawals before age 59½. Just be sure that taking money out of your IRA won’t put your retirement goals at risk.

Tip 2: Pursue Financial Aid

As your child approaches college age, you might find you don’t have enough savings to cover all the necessary costs of higher education. Fortunately, you might be eligible to receive financial aid for your child. Financial aid comes in several forms:

• Federal student loans may or may not be based on financial need, depending on which program offers the loan.
• Grants are typically based on financial need and do not have to be repaid. Most grants come from the federal government and colleges, with a few offered by state and private programs.
• Scholarships are awarded by schools and other organizations to students who excel in academics, the arts, or athletics. Like grants, scholarships don’t have to be repaid.
• The Federal Work-Study program allows college students with financial need to work on campus or for a nonprofit or private employer off campus. The program gives students a chance to earn money for tuition and living expenses in a part-time position that serves the public interest.

The Free Application for Federal Student Aid, better known as the FAFSA, is used to apply for financial aid from the federal government and, in many cases, from a state or school. Your child can submit the FAFSA as early as October 1 of the year before they will attend college. The form can be found here.

3. Take Advantage of Tax Breaks

Tax credits and a deduction may make it easier for you to afford putting your child through college:

• The American Opportunity Tax Credit, or AOTC, is a credit for up to four years of an eligible student’s qualified higher education expenses —tuition, fees and related expenses. The credit can lower your tax by up to $2,500 per eligible student: 100% of the first $2,000 of qualified expenses and 25% of the next $2,000 of qualified expenses. The credit is also “refundable,” so if it brings your tax down to zero in any given year, you can get a refund check equal to 40% of any remaining credit.
• The Lifetime Learning Credit is for qualified tuition, fees and related expenses paid for a college student, regardless of how many years the student has attended college. It’s generally worth up to $2,000: 20% of the first $10,000 spent on qualified expenses. That’s per-return, not per-student like the AOTC. Also, unlike the AOTC, the Lifetime Learning Credit isn’t “refundable.”
• The student loan interest deduction is available to you if you have a qualified student loan for yourself, your spouse, or dependent. The deduction can lower your taxable income by up to $2,500 per return. This is an above-the-line deduction, meaning it removes student loan interest from your income before you calculate your adjusted gross income for tax purposes. You don’t have to file Schedule A to claim an above-the-line deduction.

Certain additional rules are worth mentioning about the tax breaks discussed above:

• You can’t use more than one of the breaks for the same expenses in the same year.
• You can’t claim the AOTC or Lifetime Learning Credit on amounts you’ve withdrawn from a 529 plan or Coverdell ESA.
• All of the above tax breaks get restricted at higher income levels.

4. Borrow Against Your Own Assets

Borrowing from yourself may be another potential way to pay for at least some of your child’s college costs. Your options might include:

• Home equity. You may be able to take out a home equity loan or use a home equity line of credit (HELOC) to help cover education expenses. Keep in mind that under the Tax Cuts and Jobs Act, until 2026, the deduction for interest paid on home equity loans and HELOCs applies only if you borrow to buy, build or renovate your home. Also, be aware that falling behind on your loan or HELOC payments could lead to the lender foreclosing on your home.
• A life insurance loan. You can borrow against any cash value you have in a life insurance policy. You won’t owe tax on the amount you borrow.