Tax Savvy Ways to Pay for Education

The importance of an education is no secret. Statistically, lifetime earnings increase with the level of education. And with today’s changing technology the need for continued learning is high. From a tax perspective, how can you best handle the cost of education?

Get your employer to pay

Companies may offer education as a fringe benefit. The value of this benefit may be tax free to you:

• If the courses are job related, all of the cost covered by your employer is tax free.
• If the courses are not job related, then up to $5,250 can be tax free annually under a company’s education assistance plan.

Obtain a scholarship or fellowship

A scholarship or fellowship for tuition, fees, and course-related expenses is tax free as long as the student is a degree candidate at an eligible educational institution and it doesn’t represent payment for teaching, research, or other services even though required as a condition for receiving the grant. However, if the grant covers room and board or other expenses, that portion is taxable.

Obtain veteran’s benefits

The Department of Veterans Affairs (VA) offers a number of programs for education and training that are tax free. These are spelled out at the VA website (https://benefits.va.gov/gibill/).

Use a 529 plan

These plans originally were designed to cover the cost of higher education. Withdrawals for qualified education expenses are tax free.

For 2018 through 2025, up to $10,000 can be withdrawn annually to cover tuition for primary and secondary school. The IRS calls this a type of qualified tuition program.

Tap a Coverdell ESA

If you have money in a Coverdell Education Savings Account (ESA), you can use the money for a wide array of education expenses on the primary, secondary, and higher education levels.

Tap an ABLE account

These savings plans for certain disabled individuals can cover the cost of education on a tax-free basis. Withdrawals for education, including employment training, are permitted in any dollar amount.

Use education credits

If you pay out of pocket or with college loans, you may be able to take a tax credit for eligible expenses.

• American opportunity credit applies for the first four years of higher education.
• Lifetime learning credit applies for any higher education, including graduate courses.

Tap into IRAs

Savings in an IRA can be tapped to pay for higher education for you, your spouse, or dependent. There’s no dollar limit on what you can take out and even if you’re under age 59-1/2, you won’t be penalized. But remember that you’ll owe regular income tax on the distribution and you won’t be able to replace the funds (after 60 days), losing out on the buildup of retirement savings.

Take loans from 401(k) plans

If you have to pay for education and have no other resources, you can borrow from a 401(k) plan within limits. You must repay the borrowed funds ratably over no longer than five years and pay interest on this plan loan. Because this action diminished retirement savings, it isn’t recommended as a first option, but could be a fallback position.

Cash in U.S. savings bonds

If you cash in Series EE or I bonds and use the funds for certain higher education costs, some or all of the interest that’s accrued on the bonds may be tax free. However, income limits may prevent you from enjoying this tax break.

Bad tax strategies

Here are some actions to pay for higher education that trigger adverse tax consequences or no longer provide tax breaks:

• Taking a distribution from a 401(k). The distribution is taxable and if you are under age 59½, subject to a 10% early distribution penalty.
• Using a home equity loan. For 2018 through 2025, interest on a home equity loan is not tax deductible (the only exception is a loan to buy, build, or substantially improve a main or second home where the loan is secured by the home).
• Paying out of pocket. Even if the education is job related, you cannot deduct your unreimbursed employee business costs in 2018 through 2025.
• Taking a tuition and fees deduction after 2017. This above-the-line tax break for higher education expired at the end of 2017. It could be extended for 2018, but there is no assurance at this time.

Conclusion

The value of education is high but the cost of paying for it can be even higher. To the extent you use tax breaks, you can lower the cost and increase your future prospects.