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Tax Incentives to Help Reduce the High Cost of CollegeSubmitted by Integrity Advisory on August 30th, 2018
Whether you have 18 years of saving ahead of you or are already paying for college, you can benefit from using a college savings plan.
School has started again, and my wife and I have a senior and sophomore in high school, as well as a seventh grader in middle school. College is just around the corner for our oldest and not far away for the other two. Thus, college costs are on my mind, especially when faced with the following student loan debt facts:
- $1.53 trillion in total U.S. student loan debt
- 44.2 million Americans with student loan debt
- Student loan delinquency rate of 11.2% (90+ days delinquent or in default)
- Average monthly student loan payment (for borrower aged 20 to 30 years): $351
- Median monthly student loan payment (for borrower aged 20 to 30 years): $203
- The average student loan debt for Class of 2017 graduates was $39,400.
(Data via the Federal Reserve, Wall Street Journal, and the New York and Cleveland Federal Reserve Banks)
The following are some planning ideas and tax incentives that can take some of the sting out of college costs.
529 plans are state-sponsored college savings accounts that allow you to contribute funds towards college/post-secondary education costs. Beginning in 2018, funds can be withdrawn up to a maximum of $10,000 per student, per year for K-12 tuition costs. Qualified expenses for K-12 education only include tuition, which has not been further defined by the I.R.S. Currently "tuition" is defined as any mandatory fee required for enrollment.
As it relates to college expenses, funds may be used at accredited higher education institutions anywhere in the United States such as a 2- or 4-year college, vocational school or technical college, and graduate school. Your child does NOT need to attend college in your home state or even in the state that sponsored the 529 plan.
Earnings within the 529 plan are federal and state tax-free when distributions from the plan are used for qualified expenses such as:
- Mandatory fees
- Internet access
- Computer software (excluding gaming)
- Qualifying room and board costs
Many states offer tax incentives to contribute to 529 plans. For this illustration, I will touch on Kansas and Missouri. In both examples, contributions must be deposited within the 529 account by December 31st of the tax year to be deductible for that year.
As a Kansas resident, you can deduct contributions to a 529 plan from your Kansas taxable income up to $3,000 (or $6,000 if you're married and filing jointly) per beneficiary. For example, a married couple with three children can contribute up to $30,000 ($6,000 for each child and $6,000 for each of them). Currently, the top tax rate in Kansas is 5.70%, which would equate to a tax benefit of $342 for each $6,000 contribution, or a total tax benefit of $1,710.
As a Missouri resident and 529 account owner, you can deduct your contributions from your Missouri taxable income. However, you are limited to deducting up to $8,000 ($16,000 if you're married filing jointly) from your Missouri taxable income. In this example, a married couple with three children can contribute up to $16,000 total. Currently, the top tax rate in Missouri is 6.00%, which would equate to a tax benefit of $480 for each $8,000 contribution, or a total tax benefit of $960.
Kansas and Missouri are two of only five states that allow you to use any state sponsored 529 College Savings Plan and still receive state income tax deductions. All other states require you to use their state specific plans to obtain any state income benefits.
Coverdell IRA – Education Savings Account (ESA)
Coverdell ESAs are like 529 accounts, in that you can contribute funds to a college savings account that grows tax-free if used for qualified education expenses for K-12 and college. However, contributions are limited to $2,000/year per child and the beneficiary must be under age 18 during the year of the contribution (unless he or she is a special-needs child). In addition, $2,000 maximum is dependent on your filing status and modified adjusted gross income (MAGI). Joint filers with a MAGI of less than $190,000 ($95,000 for single filers) can contribute up to the full amount. Contribution limits are completely phased out for joint filers with a MAGI of $220,000 or more ($110,000 for single filers).
ESA’s offer the flexibility of allowing funds to be invested in stocks, bonds, ETFs, and mutual funds. However, any balances in a Coverdell ESA must be disbursed on qualified education expenses by the time the beneficiary is 30 years old or given to another family member below the age of 30 to avoid taxes and penalties; there is no age limit for 529 plans.
We rarely recommend Coverdell ESA’s because they offer no tax deduction for contributions, have low contribution limits, and have age limits on when the funds must be dispersed.
American Opportunity Tax Credit – AOTC
The American Opportunity Tax Credit (AOTC) is for qualified education expenses paid for an eligible student for the first four years of higher education. You can get a maximum annual tax credit of $2,500 per eligible student. The amount of the credit is 100% of the first $2,000 of qualified education expenses you paid for each eligible student and 25% of the next $2,000 of qualified education expenses you paid for that student. But, if the credit pays your tax down to zero, you can have 40% of the remaining amount of the credit (up to $1,000) refunded to you. To obtain the credit, funds must have been spent on college or post-graduate tuition, course-related books, supplies, and equipment. To claim the full credit, your MAGI must be $80,000 or less ($160,000 or less for married filing jointly). You receive a reduced amount of the credit if your MAGI is over $80,000 but less than $90,000 (over $160,000 but less than $180,000 for married filing jointly).
The Lifetime Learning Credit (LLC)
The Lifetime Learning Tax Credit provides a tax credit of up to $2,000 per taxpayer for education expenses. The amount of the credit is equal to 20% of the first $10,000 of qualified tuition and related expenses paid by the taxpayer. There is no limit to how many years this credit can be claimed, and it can only reduce the amount of taxes you must pay. However, it is not refundable like the AOTC. To claim the full credit, your MAGI must be $66,000 or less ($132,000 or less for married filing jointly). You receive a reduced amount of the credit if your MAGI is over $56,000 but less than $66,000 (over $122,000 but less than $132,000 for married filing jointly).
In summation, you can find some very beneficial tax incentives using 529 plans, as well as obtaining tax credits via the AOTC and LLC for those who qualify. However, strategies presented in this commentary are just the basics of college planning. Click HERE for a chart which highlights the differences between the tax benefits of each strategy. There are certain adjustments that may need to be made for scholarships, other financial aid received, your income level, etc. As such, we can work closely with you and your tax professional to make sure you make the most of the money you wish to use for educational purposes.
Current Health of the U.S. Economy
The current bull market may be the longest of all time, but that does not mean it needs to end anytime soon. Here is why:
Last week, in a speech delivered before the Jackson Hole Economic Symposium on Friday, Federal Reserve Chairman Jerome Powell said, “Over the course of a long recovery, the U.S. economy has strengthened substantially… With solid household and business confidence, healthy levels of job creation, rising incomes, and fiscal stimulus arriving, there is good reason to expect that this strong performance will continue.” Also, he went on to note, “While inflation has recently moved up near 2%, we have seen no clear sign of an acceleration above 2%, and there does not seem to be an elevated risk of overheating,” Powell said
It appears that Mr. Powell believes that the U.S. economy is strong and inflation concerns are minimal, and as a result, future interest rate hikes should be manageable for the U.S. economy (as well as the stock market).
The following chart from the U.S. Commerce Department shows that in 2018, the U.S. economy is forecasted to grow at its fastest pace since 2005.
In addition, earlier this month, Walmart’s Chief Financial Officer Brett Biggs said the world’s biggest retailer reported its strongest U.S. sales gain in more than a decade. “Customers tell us that they feel better about the current health of the U.S. economy as well as their personal finances.”
Consumer finances are in better shape than previously thought, according to revised government data. The savings rate over 2016 and 2017 is now pegged at an average 6.7%, up from a previously reported 4.2%, partly because small-business owners and other proprietors made more money than previously estimated.
The widely-known and highly-respected stock market historian, Dr. Jeremy Siegel, told CNBC last week that he believes the stock market could increase another 10% this year if the U.S. were to settle its trade war with China and reach a new North American Free Trade Agreement. During the interview last week, he noted, "But if we can get China [and] NAFTA settled, I see a 10% pop in the market because I think that's the kind of 800-pound gorilla keeping a lid on prices now." Dr. Siegel went onto to state, "The previous longest bull market ended in March of 2000 with a price-earnings ratio at 30 for the S&P. We're looking at 18 right now for looking at this year's earnings," he said, contending the current market is "much less overvalued."
In addition, interest rates are also much lower now than they were after the dot-com bubble burst in 2000, he argued, saying the last bull market and this one feel nothing like one another. Siegel said a market multiple of 18 to 20 times earnings in a "low rate environment with a stable economy" is not too lofty.
However, he did point out some headwinds including trade uncertainty, a Federal Reserve that is raising rates, and the midterm elections.
Overall, the current bull market is long in the tooth, and has been one of the most hated in history. As such, much of the fundamental economic numbers referenced above support our belief that even though we may face some volatility going forward, the trend of the U.S. stock market is higher for now.
Tony Moeller, CPA
The information listed in this commentary is a compilation of various publicly available sources and is for informational purposes only. It is not a recommendation or solicitation of any investment or strategy. A risk of loss is involved with investments in the stock and bond markets.
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