Get Help in Paying for College from Uncle Sam

The average cost of one year of education (tuition, fees, room and board) is $13,589 for 2007–2008 at a public school for in-state students and $32,307 at a private school. Fortunately, your Uncle Sam provides some assistance via government loan programs and tax incentives. Here are some breaks to look into to ease the burden of pursuing higher education.

Government loan programs

The largest source of college loans is federal loans. Federal loans are attractive because they carry lower interest rates than other loans, interest accruing while in school may be paid by the federal government, there's no repayment required while in school, and there are longer repayment terms than with other loans.

The main programs are:

• Federal Family Loan Program. Loans are obtained through private banks, credit unions, or education finance companies.

• Direct Federal Loan Program. Loans are obtained through participating schools with funds borrowed from the U.S. Department of Education.

Find out about federal loan programs from Sallie Mae's College Answer at www.collegeanswer.com/paying/content/pay_under_fed.jsp.

Tax incentives

Federal tax law provides certain breaks to help ease the pain of paying for college. Most of the breaks are dependent on your income; too much income and you become ineligible to claim them.

Scholarships. There are over 20 million scholarships each year worth more than $1 trillion from government programs, nonprofit organizations, and corporations that support education. If you are enrolled in a degree program, the portion of a scholarship, fellowship, or grant for tuition, course-related fees, books, supplies, and equipment is tax free (there's no dollar limit on this benefit). This exclusion applies whether the scholarship is awarded on the basis of financial need, scholastics, or special talent (e.g., athletics or music).

Education credits. A tax credit reduces your tax bill dollar for dollar, so a $100 tax credit savings you $100 on your taxes. There are two education credits:

• Hope scholarship credit — limited to the first two years of higher education and figured on a per-student basis. The top credit in 2007 is $1,800 per eligible student.

• Lifetime learning credit — available for any higher education and figured on a per-family basis. The top credit in 2008 is $2,000 per return.

• The credits can be claimed only if your modified adjusted gross income (MAGI) does not exceed set limits; a partial credit can be claimed if your MAGI is within the phase-out range.

*No credit may be claimed for married filing separately.

However, a parent can choose not to claim a student as a dependent, which enables the student to claim the credit. This choice makes sense if the student has sufficient investments and earnings to generate a tax bill that can benefit from the credit offset.

Tuition and fee deduction. Whether or not you itemize your personal deductions, you can claim a limited deduction for tuition and fees. This deduction is subtracted from your gross income to arrive at your adjusted gross income. The top deduction is $4,000 for those with modest income (a $2,000 deduction applies for those with higher income).

*No credit may be claimed for married filing separately.

You can't take both an education credit and the tuition and fees deduction with respect to the same education costs. A credit will usually provide the greater tax savings, but the income limits for these rules may entitle you only to a deduction and not to the credit.

Redemption of savings bonds. If you hold Series EE or I U.S. savings bonds and cash them in, the interest may be partly or fully tax free as long as the proceeds are used to pay tuition and fees. Here are some key points to note:

• Bonds must be held in the parent's name; those in the child's name do not qualify. Bonds held by a grandparent usually don't qualify for this treatment.

• Bonds must have been acquired by the parents after 1989, and the child must be 24 or older when cashing them in.

• Income of the parents in the year the bonds are redeemed may prevent tax-free treatment of interest (income in the year the bonds are purchased is irrelevant).

*No credit may be claimed for married filing separately.

Note: Interest on U.S. savings bonds is never subject to state income tax, under any circumstances.

IRA withdrawals. If you experience a cash crunch, you can tap into your IRA to pay tuition, fees, books, and required supplies and equipment for college. Withdrawals are taxable, but those under age 59½ are excused from the 10% early distribution penalty in this case.

Caution: Using IRA funds for education should probably be a last choice. The purpose of an IRA is to provide retirement benefits, so using money to pay for college will mean it won't be there for its intended purpose. Also, because funds are taxable, you have to withdrawal enough to cover both the college expenses and income taxes.