Unlocking Tax-Efficient College Savings

Unlocking Tax-Efficient College Savings

Discover how you and your family can utilize tax-efficient savings plans for college.

The cost of attending college continues to rise each year. Now, it’s more important than ever for parents and students to exercise proactive college tuition planning. 

This usually begins with a well-structured college savings plan and understanding the nuances of tax-efficient strategies that help boost savings, minimize tax burden, and make your money work for you. 

Why College Savings Are a Must

According to the Education Data Initiative, the average cost of college is about $38,000 per year. This number also accounts for living and supplies expenses.

Higher Education Policy uncovered that most college students have “unmet need and experience gaps” between what students’ families can afford and the price of college. 

With college costs only continuing to rise, starting early and leveraging tax-efficient savings strategies is crucial.

Taking the time to start planning for college now carries several benefits. One of the most significant is the ability to plan ahead and prepare for different financial scenarios when the time comes to attend college.

You’ll be able to proactively answer questions like:

• What if you have to dip into your college savings to cover an emergency expense? 
• What if the original college of choice changes? 
• What if your college savings aren’t enough to cover everything?

Ultimately, employing tax-efficient college savings strategies as early as possible makes your funds go as far as they possibly can.

Let’s look at a few of the most popular college savings options.

529 College Savings Plans

A 529 plan is usually the go-to tax-efficient college savings option. These are state-sponsored investment accounts designed specifically for education expenses. 

They offer significant tax advantages, including:

• Tax-deferred growth: Earnings in a 529 plan grow tax-deferred. In other words, as your investment compounds over the years, you won’t pay taxes on that growth, allowing your savings to accumulate more rapidly.
• Tax-free withdrawals: When it comes time to pay for college, withdrawals from a 529 plan for qualified education expenses—such as tuition, fees, books, and room and board—are tax-free.

Moreover, many states offer tax breaks for 529 plan contributions, providing an immediate tax benefit. These breaks vary by state, so it’s a good idea to discuss your specific state’s tax benefits with a qualified tax professional.

Coverdell Education Savings Accounts (ESAs)

Another option is the Coverdell ESA, which offers another tax-efficient way to save for college. 

These accounts also provide tax-free growth and tax-free withdrawals for qualified education expenses. 

However, there are some key differences between ESAs and 529 plans:

• Contribution limits: Coverdell ESAs have a relatively low annual contribution limit of $2,000 per beneficiary.
• Income restrictions: Contributions to a Coverdell ESA are phased out for higher-income individuals, making them less accessible to some families. For instance, they’re not available for those with incomes over $220,000.
• Qualified expenses: One advantage of Coverdell ESAs is their flexibility. Unlike 529 plans, Coverdell ESAs can be used to save for kindergarten all the way through to college.

Fortunately, you don’t have to choose between an ESA and a 529 plan. Your family can contribute to both in the same year if you qualify, and the beneficiary can receive education funds from both types of accounts.

Roth IRAs

Roth IRAs are typically associated with retirement savings but can also be helpful for college savings. You make Roth IRA contributions with after-tax dollars, but the earnings grow tax-free, and qualified withdrawals are also tax-free.

Unlike 529 plans and ESAs, Roth IRAs are not exclusively tied to education expenses. If your child decides not to attend college, for instance, you can keep the Roth IRA for your own retirement without any penalties.

Note that if you haven’t had the Roth IRA account for at least five years and you’re under 59 ½, investment earnings that you withdraw will be subject to income taxes. Roth IRAs also have annual contribution limits to be aware of.

Education-Related Tax Credits

In addition to tax-efficient savings accounts, federal tax credits can help you reduce the cost of college. 

Take the American Opportunity Tax Credit (AOTC), for instance. The AOTC could reduce your tax liability by $2,500 and can be claimed for no more than four years. 

To claim the full credit, your modified adjusted gross income (MAGI) must be $80,000 or less ($160,000 or less for married couples filing jointly). This credit is refundable, meaning that even if your tax liability is reduced to zero, you could receive up to $1,000 as a refund.

Then, there’s the Lifetime Learning Credit (LLC). The LLC is another federal credit that offers up to $2,000 in reduced taxes. The LLC is nonrefundable, so it can only reduce your tax liability to zero. However, this credit has no tax year limit for which you can claim it.

Balancing College Savings With Other Financial Goals

There is certainly no shortage of life events to save for, whether that’s college, retirement, a home purchase, or starting a business. Tax-efficient college savings plans also take into account how those dollars will work in conjunction with your other savings goals.

For instance, it’s imperative to still prioritize retirement savings; the financial assistance that exists for college expenses doesn’t exist for retirement, and sacrificing savings for one purpose to be used in another is usually an inefficient way of approaching your financial goals.

Use tax-efficient strategies for college and retirement savings to ensure long-term financial stability and make the most of your money over time.

Unlock Tax-Efficient College Savings With Help From Avior

Unlocking tax-efficient college savings involves selecting the right savings vehicles, understanding tax credits, and balancing education with your other savings goals. 

To increase the value of your college savings, take a proactive approach and start as soon as possible. 

Talking your options over with a financial professional is never a bad idea. At Avior, we help you see the big picture and align your education savings goals with your complete financial plan.

Set up a call with us to get started with your own tax-efficient college savings plan.

Disclaimer: Nothing contained herein should be construed as legal or tax advice. Avior and our Advisors will work with your attorney and/or tax professional to assist with your legal and tax strategies. Please consult your attorney or tax professional with specific legal and/or tax questions. Investment Management and Financial Planner are offered through Avior Wealth Management, LLC, an SEC-registered investment advisor. Past performance is not a guarantee of future results.  Investments are subject to loss, including the loss of principal.