If you have kids, you know that education is going to cost serious money. In fact:
- Daycare & Preschool can cost $1500-2500 per month.
- Private Primary and Secondary school in New York City can cost almost $40,000 per year.
- College expenses have increased at roughly twice the rate of inflation for decades, and now range from $9000 to 36,000 per year.
What’s a parent to do? Obviously you need to start saving – yesterday. There are some tax-advantaged savings vehicles out there, and I recommend taking advantage of every one you can get. Here are the basics, through the years:
For Kids in Daycare & Preschool
It’s not technically school at all, but it is definitely expensive. A little help is available:
- Dependent Care Savings Account. You may be able to set aside up to $5000 in pretax money in an account, if it is offered through your employer. Using pretax money may substantially lower your tax bill. (Warning – this is a good one if you use daycare, not a babysitter you pay with cash. You’ll need to submit receipts and tax id number for reimbursement.)
- Dependent Care Credit. You can generally take a 20% credit for up to $3000 in expenses for one child, or $6000 for two or more children. This means a credit of $600-1200.
- Depending on your income, you may be eligible for one of these, but not both. Consult your tax adviser.
For Kids in Primary and Secondary School
- Your tax strategies are limited here, probably because public school is F-R-E-E. If both parents work, you may be able to get some help for camps or after school care from the Dependent Care Credit (same as above) up until age 13.
- The Coverdell ESA (Education Savings Account) can be used for primary, secondary or post-secondary education expenses. Contributions are not tax deductible, but do grow tax-deferred. Unfortunately, the limits are rather restrictive: you can only save $2000 per child, per year, which is just not enough, and there is an income limit of $110,000 (or $220,00 for joint return).
- Gifting. If you are lucky enough to have a generous relative who wants to help pay for school, ask them to pay the school directly. Direct payments for health or education expenses are not considered taxable gifts. The taxable gift limit is currently $13,000.
For College and Post-Secondary Schools
- The big one to know is the 529 College Savings Plan. Savings grow tax-free in the account, and withdrawals are tax free as long as they are used for education expenses. There are no income limits, and in New York, you even get a State (not Federal) tax deduction for contributions up $5000 (or $10,000 if married filing jointly). Investments are limited to what is in the plan, but this is an excellent choice for many parents.
- Education Savings Bonds. You may be able to exclude interest earned on US Savings bonds from income if the funds are used for post-secondary education. BUT, there are income limits ($136,650 for married persons filing jointly).
- Depending on your age, a Roth IRA may be a good choice for education expenses. It may be a scary thought, but if you were around 40 when you child was born, you’ll be around the magic age of 59 and 1/2 when your child is ready for college, and withdrawals will be tax and penalty free. (Unless certain criteria are met, Roth IRA owners must be 59½ or older and have held the IRA for five years before tax-free withdrawals are permitted.)
- You can create a bond ladder. Buy bonds (government or corporate) scheduled to mature at about the time tuition is expected to be due. There is no particular tax advantage here, but I like the timing strategy – funds are scheduled to be available when they will be needed.
- Some people buy cash value life insurance, with the purpose of building savings for education, while at the same time providing protection in the event of a parent’s death. Taking a loan against the cash value of a life insurance policy is tax-free, but it takes a looong time to build significant value in the account for most people. I don’t recommend this, as there are plenty of lower-cost ways to save, but I have seen it done.
In summary, education expenses are likely to be big, and there is more than one way to skin a cat. You need to save early and often, and it’s worth it to save taxes wherever you can.
That being said, recognize that it may not be possible to fully fund your child’s education, especially if you are starting later (and your child wants to attend a private school). In my own experience, I see families funding education through some combination of savings, loans, scholarships, and current earnings (theirs and maybe the kids’ too); and that is OK!
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