College savings plans, also called Section 529 plans, are a tax-favored savings account. Similar to IRAs and other savings plans, 529 plans allow people to save for college expenses by funding a special type of account. The key benefits: earnings and growth of investments inside the account accumulate without being taxed, and withdrawals from 529 plans are tax-free as long as they are used for specified higher education expenses. If the funds aren't used for education-related expenses, the distributed funds will be subject to taxes and a 10% surtax. College savings plans are sponsored by state governments, although you are free to invest through any state's 529 plan. Some states offer incentives for investing their their plan.
- Overview of 529 College Savings Plans
- States that offer tax incentives for 529 Plans
- 529 Prepaid Tuition Plans
There are two tax credits for higher education. The American Opportunity credit provides a refundable tax credit of up to $2,500 for undergraduate education. The American Opportunity Credit is scheduled to expire at the end of 2012. The Lifetime Learning Credit provides a tax credit of up to $2,000 for any level of college education (even graduate school), and doesn't require a minimum level of enrollment. However, the Lifetime Learning Credit has a narrower income range compared to the tuition deduction.
Deducting interest on student loans. Students often take out loans to pay for college expenses. Interest on student loans may be deductible up to $2,500 per year. Be aware that this deduction is gradually phased out as your income raises. This deduction may change after 2012 to provide that interest is deductible only for the first 60 months of repayment. Like the tuition deduction, the student loan interest deduction is taken directly on your tax return and doesn't need to be itemized.
No education-related tax deduction or credit is allowed for taxpayers who are married but filing separately. Separate filers are not eligible for the American Opportunity credit, Lifetime Learning Credit, the tuition and fees deduction, or the student loan interest deduction.