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Tax incentives and college savings

One of the best ways to increase the affordability of your child's education is to take advantage of federal tax breaks aimed at families saving and paying for college. These include the following:

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Qualified tuition programs (529 plans)
Earnings grow tax-deferred and distributions are tax-free when used for qualified post-secondary education costs before 2011.

Coverdell Education Savings Accounts
Earnings grow tax-deferred and distributions are tax-free when used for qualified post-secondary education costs. May also be withdrawn tax-free for primary and secondary school expenses before 2011.

U.S. savings bonds
EE and I bonds purchased after 1989 by someone at least 24 years old may be redeemed tax-free when bond owners, their spouses or dependents pay for college tuition and fees. In 2005, the tax exclusion is phased out for incomes between $61,200 and $76,200 (between $91,850 and $121,850 for married taxpayers filing jointly). These income limits increase each year.

Individual Retirement Accounts
Early withdrawal penalties are waived when Roth IRAs and traditional IRAs are used to pay the qualified post-secondary education costs of yourself, your spouse, your children, or your grandchildren. (Taxes may still be due on the withdrawals, however.)

Hope Scholarship Credit
A parent may claim a tax credit for 100 percent of the first $1,000 and 50 percent of the next $1,000 of a dependent child's college tuition and mandatory fees, for a maximum $1,500 annual tax credit per child. Students may claim the credit only if they are not claimed as a dependent on another person's tax return. The credit is allowed only for students who are attending a degree program at least half-time and who have not completed their first two years of academic study before the beginning of the taxable year. It cannot be claimed in more than two tax years for any one student.

Lifetime Learning Credit
A taxpayer may claim a tax credit for 20 percent of up to $10,000 in combined tuition and mandatory fees for himself, his spouse and his dependent children. This equates to a $2,000 tax credit. In 2005, the credit is phased out for incomes between $43,000 and $53,000 (between $87,000 and $107,000 for married taxpayers filing jointly). Claiming the Hope Scholarship credit described above means that you may not claim a Lifetime Learning credit for any of that student's expenses in the same tax year. There is no requirement that the student be studying toward a degree or be enrolled at least half-time, and there is no limit on the number of years the credit may be taken.

Tuition and fees
An above-the-line deduction (this means you do not have to itemize your deductions) for up to $4,000 of the college tuition and related expenses of yourself, your spouse or your dependent is available in 2004 and 2005 if your income is $65,000 or less ($130,000 or less if you are married filing jointly). For taxpayers with incomes between $65,000 and $80,000 (between $130,001 and $160,000 for married taxpayers filing jointly), the deduction limit is $2,000. The deduction is not available if anyone claims a Hope or Lifetime Learning credit for that student's expenses in the same tax year. This deduction disappears after 2005.

Deduction for student-loan interest
Up to $2,500 in student loan interest may be deducted above-the-line as long as the debt was incurred to pay the college costs for yourself, your spouse or your dependent, while enrolled as a student at least half-time in a degree program. For 2005, the full deduction is allowed for singles with income below $50,000 and a partial deduction is allowed for singles with income up to $65,000. Married couples filing jointly get the full deduction with income up to $105,000 and a partial deduction with income up to $135,000. A student claimed as a dependent may not take the deduction on his or her own return.

Tax-free scholarships
Most scholarships and grants are tax-free if the recipient does not have to provide services in exchange for the award.

Tax-free educational assistance
Employers may pay and deduct up to $5,250 in college and graduate school costs for each employee under a Section 127 educational assistance plan. The education does not have to be job-related. The benefit is tax-free to the employee, but cannot be used to pay for an employee's children or other family members.

For more information on tax incentives for education, see IRS Publication 970, Tax Benefits for Higher Education, available at

Excerpted from's "Family Guide to College Savings"

"The information contained in this material and related materials ("Information") is based on information from sources believed to be accurate and reliable and every reasonable effort has been made to make the Information as complete and accurate as possible but such completeness and accuracy cannot and is not guaranteed. The reader and user of the Information should use the Information as a general guide and not as the ultimate source of information. The Information is not intended to include every possible bit of information regarding the Information but rather to complement and supplement information otherwise available and the reader and user should use the Information accordingly. The Information contains information about tax and other laws and these laws may change. The reader and user should realize that any investment involves risk and the assumptions and projections used in the Information may not be how the investments turn out. The reader and user should consult with their own tax, financial and legal advisers about all of the Information."
-- Posted: March 31, 2005




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