by Archie M. Richards, Jr., CFP^®
January 20, 2003

If you face educational costs for a member of your family, the following tax benefits might help:

529 Plans: No matter how high your taxable income, you can sock away over $100,000 a year in a 529 Plan. The contributions are not deductible, and you must make them by December 31.

The plans are sponsored by state governments. You can use the plan of any state. The state selects a company to manage the investments. Those that are managed by Vanguard have especially low costs.

The earnings within the plan grow tax free. The distributions are not subject to federal income tax providing they're used for educational purposes - even room and board.

You can name yourself or anyone in the family as a beneficiary. "Family" is defined broadly, even including first cousins or the spouses thereof. You can change beneficiaries whenever you like.

Coverdell Education Savings Accounts: You can contribute up to $2,000 a year to a Coverdell, even if you also have a 529 plan. The contributions are not deductible, but you can make them as late as April 15 of the following year. Unless the student has special needs, you must discontinue contributions when he or she reaches age 18.

Earnings within the plan are tax free. The distributions are not federally taxable providing they're used for tuition and fees, the costs of books, supplies and equipment, and in some situations, room and board.

The account must be closed when the beneficiary reaches 30. But the funds may first be transferred to a Coverdell or 529 plan for another member of the family.

Hope Credit: A credit reduces the actual tax dollar for dollar. It beats a deduction, which only reduces the income on which the tax is based.

You can take a credit of up to $1,500 for tuition and fees of an accredited, educational institution in which the beneficiary is enrolled at least half the time. The Hope Credit applies only to the first two years of college. The beneficiary may be you, your spouse, or someone you claim as a dependent.

Lifetime Learning Credit: This applies to tuition and fees for any year of higher education. The credit can apply to one or more courses, even for acquiring or improving job skills.

For 2002, the credit is 20 percent of the first $5,000 of qualified expenses - a maximum of $1,000. For 2003, the credit is 20 percent of the first $10,000 of expenses - a maximum of $2,000.

Tuition Deduction: You can deduct from your taxable income up to $3,000 for tuition and fees for eligible institutions of higher learning. The deduction is available for yourself, your spouse, or a dependent.

IRA Distributions: Distributions from a traditional IRA are taxable, and distributions prior to age 59½ are penalized an extra 10 percent. But if the distribution is made for education, the penalty is excused.

Student Loan Interest Deduction: If you borrow to help pay for a degree program in which the student is enrolled at least half the time, you can deduct up to $2,500 of the interest. You can claim the deduction even if you don't itemize. The student may be yourself, your spouse, or a dependent.

Savings Bond Interest Exclusion: If you cash in a Series EE or a Series I savings bond, you can exclude the interest from your taxable income if the proceeds apply to tuition and fees for higher education. The bonds must have been purchased after 1989 by a person 24 or older.

You can adopt many of these plans in the same year. But two programs cannot be used for the same expense.

Except for 529 plans, all of these programs are phased out if your income exceeds certain levels. IRS Publication 970 contains this and other information. (See www.irs.gov > forms and publications.)

Government provides educational assistance in many ways, partly because the costs of education are high. But I believe the causation runs the other way: The costs of education are high because the government provides so much assistance.