529 College Savings Plans

College Tax Credits

The Hope Credit and Lifetime Learning Credit offer another way to reduce your taxes while paying for college. Available for only the first two years of college, the Hope Credit equals 100% of the first $1,000 paid for college tuition and fees and 50% of the second $1,000, for a maximum credit of $1,500 per student. To qualify for the Hope Credit, your child must be pursuing a degree, going to school at least half time, and not have a felony drug conviction.

With the Lifetime Learning Credit, you can claim up to 20% of the first $10,000 paid for college tuition and fees, for a maximum credit of $2,000 per tax return. Unlike the Hope Credit, there is no limit on the number of years you can claim the Lifetime Learning Credit. It may be used for undergraduate and graduate courses and even for tuition and fees when your child is attending school less than half time. But, you can only claim the credit once per tax return no matter how many children you have enrolled in college at the same time.

The full credits are available to you if your modified adjusted gross income is less than $40,000 if you are a single taxpayer and $80,000 if you are married filing jointly. The credits phase out if your modified adjusted gross income is between $40,000 and $50,000 if you're a single taxpayer and between $80,000 and $100,000 if you are married filing jointly. You can't get either of these credits if your modified adjusted gross income is above $50,000 if you are a single taxpayer, above $100,000 if you are married filing jointly or you are married filing separately.

If you qualify for a Hope Credit or Lifetime Learning Credit, you can still claim the credit even if you make a withdrawal from a 529 plan or ESA. You just can't use the credits to pay expenses paid with 529 or ESA money. Prior to 2002, you could not claim these credits if you made a withdrawal from a 529 or ESA.

More information on the availability of these credits can be found in IRS Publication 970: Tax Credits for Higher Education.

Tips for Choosing College Savings Options

Understand the Tax Benefits

A number of college savings options offer tax-advantaged ways to save. Taking advantage of these savings options may greatly affect how much you can accumulate for your child's college education. In addition to the federal tax benefits of many college savings options, there may also be state tax benefits. Savings bonds are usually exempt from state and local taxes. Many states allow you to deduct some or all of your contributions to a 529 plan if you're a resident of the state sponsoring the plan. In addition, states may offer other tax advantages for 529 plans. Because of these state tax benefits, you might want to check out your own state's 529 plan before considering out-of-state plans.

Everyone's tax situation is different and state and federal tax law can be complex. You may want to consult with your tax advisor about which college savings options are best for you.

Examine Fees and Expenses

All of the college savings options discussed above involve various fees and expenses. A college saving option with higher costs must perform better than a low-cost option to generate the same returns for you. Even small differences in fees and expenses can translate into a large difference over time.

While we explain the various expenses involved with many 529 plans, that does not mean that other college savings options don't have fees and expenses. If you invest in mutual funds through an ESA or custodial account, you should check the fee table in the prospectus to see how the costs of a mutual fund add up over time. If you invest in stock, make sure you understand how much in commissions you must pay and factor this into any gain you may make.

Know the Risks As Well As the Rewards of Your College Savings Options

Compared to saving for retirement, your college saving timeline is relatively short. At most it may be 18 years. And for many people it's a lot less. This can impact your ability to weather a market decline and increases your risk.

Before investing in any college saving vehicle, carefully evaluate it and its investment options. Investment options with higher rates of return may take risks that are beyond your comfort level and are inconsistent with your goals. To learn more about the investment strategy of investment options you are considering and their risk, you should read the following materials:

529 Plans. Read the offering circular or prospectus. It usually contains the investment strategy and risks of a 529 plan and its investment portfolios. Most 529 plans provide this document on their Web sites.
Mutual Funds. Read the prospectus and shareholder reports. Prospectus and shareholders reports are usually available from mutual fund companies or your financial professional. Mutual fund prospectuses also are available in the SEC's EDGAR database.
Stocks and other securities. Read a company's registration statement or annual (Form 10-K) and quarterly (Form 10-Q) reports. These are typically available in the SEC's EDGAR database. For companies that don't file in EDGAR, email the SEC's Public Reference Room to see whether the company has filed any documents with the SEC.

Understand Your College Savings Plans Limitations and Restrictions

What happens to your college savings if your child decides not to go to college, you have another child, or you lose your job? These events and many others could dramatically impact your college savings strategy. Unfortunately, most college savings options have various restrictions and limitations that may impact your ability to react to a changing situation. Carefully review any college saving options you're considering to make sure they have the flexibility and control you feel you need.

Our College Savings Plan Comparison Chart will help you understand and compare the various restrictions and limitations of each option.

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