How to Plan for Your Child’s Looming College Costs

by Netha Sethia, CPA

According to Bloomberg, college tuition and fees have increased 1,120% since 1978.  How do young parents manage the potentially large costs looming in their children’s future?  There are two tax-favored options that might be beneficial: a qualified tuition program and a Coverdell education savings account. Each of these options has their benefits and limitations, but the sooner you choose to make the investment in your child’s future, the greater the tax savings.Qualified Tuition Program (QTP). A qualified tuition program (also known as a 529 plan for the section of the Tax Code that governs them) may be a state plan or a private plan. A state plan is a program established and maintained by a state that allows taxpayers to either prepay or contribute to an account for paying a student's qualified higher education expenses. Similarly, private plans, provided by colleges and groups of colleges allow taxpayers to prepay a student's qualified education expenses. These 529 plans have, in recent years, become a popular way for parents and other family members to save for a child’s college education. Though contributions to 529 plans are not deductible for Federal tax purposes, there is also no income limit for contributors.  Qualified expenses include tuition, required fees, books and supplies. For someone who is at least a half-time student, room and board also qualifies as higher education expense. 529 plan distributions (including the earnings in the plan) are tax-free as long as they are used to pay qualified higher education expenses for a designated beneficiary.Another benefit for Illinois residents is the state of Illinois offers one of the largest Section 529 tax deductions of any state.  The maximum deduction allowed is $10,000 per taxpayer.  Couples filing a joint return are permitted a combined Illinois tax deduction of $20,000. Please note, only contributions made to the Illinois Bright Start, Bright Directions, or College Illinois Prepaid Tuition program are eligible for an Illinois tax deduction.Coverdell education savings accounts. Coverdell education savings are custodial accounts similar to IRAs. Funds in a Coverdell ESA can be used for K-12 and related expenses, as well as higher education expense. The maximum annual Coverdell ESA contribution is limited to $2,000 per beneficiary, regardless of the number of contributors. Excess contributions are subject to an excise tax.Entities such as corporations, partnerships, and trusts, as well as individuals can contribute to one or several ESAs. However, contributions by individual taxpayers are subject to phase-out depending on their adjusted gross income. The annual contribution starts to phase out for married couples filing jointly with modified AGI at or above $190,000 and less than $220,000 and at or above $95,000 and less than $110,000 for single individuals. Contributions are not deductible by the donor and distributions are not included in the beneficiary's income as long as they are used to pay for qualified education expenses. Earnings accumulate tax-free. Contributions generally must stop when the beneficiary turns age 18, except for individuals with special needs. Parents can maximize benefits, however, by transferring the older siblings' account balance to a younger brother, sister or first cousin, thereby extending the tax-free growth period.Of course, in planning for higher-education costs, parents may also choose to use funds from an individual retirement account or a traditional form of savings. In addition, higher education costs may be supplemented with scholarships, loans and grants. However, having a viable plan as early as possible in a child's life will make maximum use of a family's financial resources and may provide some tax benefit. 
If you have any questions, please feel free to call me at 847+733+7189 or email me at nsethia@bkl-cpa.com.