From The Portsmouth Herald, August 13, 2010
Money Talk: Be tax savvy when college begins
How to minimize impact of first tuition bill
By David T. Mayes, MA, EA, CRPC(R), CFP(R)
It is no secret that the cost of a four-year college degree has increased rapidly in recent years. Even if you have planned well for the expense, you may still have questions about how you are going to pay the tuition bills when they come due or whether there are steps you can take to reduce the impact of college on your pocketbook.
Most of today's undergraduate students pay for their education by borrowing, thus graduation yields both a degree and a substantial loan balance. According to The Project on Student Debt, two-thirds of students graduating from four-year colleges had student loan debt in 2008. The average debt level for graduating seniors was $20,200 at public universities. At the current student loan interest rate of 6.8%, this translates to a monthly payment of $232.46 after graduation.
So, how can you minimize the impact of that first tuition bill? You may already know about the tax breaks available to help with college expenses, but the logistics of claiming them are generally new learning for parents and students.
Parents who have established Section 529 plans for their children are often confused about how to access these tax-favored savings accounts when college expenses come due. Withdrawals from these plans are tax-free when used for qualified higher education expenses. If used for any other purpose, investment earnings are subject to ordinary income tax, plus a 10% penalty. When using 529 plan monies to pay for college, you want to be careful about the timing and amount of your withdrawals to make sure that the tax benefits are not lost.
At tax time, your 529 plan custodian will issue a form 1099-Q showing the amount that was taken out of the plan during the year. This information is provided to the IRS, so any earnings withdrawn from the account must be reported on the tax return of the person who received them. Distributions can be made payable to you or your child without impacting the tax consequences. As long as the tax return reporting the 1099-Q distribution amount shows an equal or greater amount of qualified higher education expenses, none of the withdrawal will be taxable. However, it may be best to have distributions made to your child so that the IRS can more easily match them with the 1099-T forms provided by the school showing the amounts billed during the year.
If you plan on taking advantage of the American Opportunity Credit, keep this in mind when scheduling your 529 plan withdrawals. This partially-refundable credit is treated as a tax payment of up to $2,500 on your tax return. To receive the maximum credit, you will need to report $4,000 of college expenses on your tax return, but you cannot use the same higher education expenses to qualify for both the credit and tax-free treatment of you child's 529 plan. To avoid tax, you may need to reduce your 529 plan withdrawal to account for the expenses used to qualify for the tax credit. If the distributions are made payable to your child, and you claim the tax credit on your return, your child must reduce the higher education expenses she reports on her return, even if she is not claiming the credit.
In addition to taking maximum advantage of the tax code to cut your college bills, contact your auto insurer to see if you can receive a discount on your policy. If college is more than 100 miles away, your insurer will likely consider them an infrequent driver and give you a break on your premiums. Finally, before you unpack the extra-long fitted sheets for that new dorm room, have your child sign a health care proxy naming you as agent. While you have been making health decisions on her behalf for the last 18 years, state law now treats your child as an adult. In order to continue overseeing her medical care, you will need her written consent. Having this document in place will leave you prepared for the unexpected, so that all you have to worry about is the tuition bills. If only it were that easy.
David T. Mayes is a CERTIFIED FINANCIAL PLANNERTM professional and IRS Enrolled Agent at Mackensen & Company, Inc., a fee-only advisory firm in Hampton. He can be reached at (603) 926-1775, david.mayes@mackensen.com or by visiting www.mackensen.com.