More ideas on saving for college

John W. Schoen Senior Producer • Profile • E-mail

Our story last week on saving for college drew a number of questions and suggestions from readers. Jennifer in California thinks we should add IRAs to the list of saving vehicles. (Good idea.) Jean in New Jersey is looking for a tax deduction for helping a niece pay tuition bills (a long shot.) And Konrad in Arkansas is worried that he may owe taxes on his supposedly tax-free 529 savings plan (and so might you if Congress doesn't act.)

COLLEGE IRAS?
What about Roth IRA’s?  The limit this year is $4,000.00. The earnings are tax free if used for education purposes. If your child decides not to go to college, you can keep the money for retirement.
-- Jennifer L., Perris, Calif.

Absolutely. Aside from the numerous plans set up specifically for college savers, IRAs are great way to set aside money and save on taxes. You get to keep control of the money, you have more investments to choose from than 529 plans and there are provisions for penalty-free withdrawals for education expenses. And of course IRAs let you grow your investments tax free. (The main different is that with a Roth IRA, which you fund with after-tax dollars, you won’t have to pay income tax when you withdraw the money.)

If your child has a summer job, you may also want to consider opening the IRA in their name. You can deduct the contributions to a traditional IRA from their earnings, cutting their tax bill. Keep reading for more on other deductions they may be eligible for.

COLLEGE DEDUCTIONS
Are there any ways that I can put money aside for my niece and get a tax deduction for myself? 
--Jean P., Linden, N.J.

The simple answer? Probably not.

First of all, you can only deduct college expenses for yourself, your spouse, or a dependent. So unless your niece lives with you as a member of your household and meets the other conditions for being claimed as a dependent, you’re out of luck.

For a dependent, college expenses of up to $4,000 are deductible from your return, but you’ll have to meet several conditions. You can’t have adjusted gross income of over $80,000 ($160,000 for married couples).  And only certain expenses qualify: tuition, books and fees are on the list; room and board are not.

Keep in mind that if you’ve set up an account in the child’s name that pays a substantial part of their living expenses, they may no longer qualify as a dependent on your return. Generally, you can’t claim someone as a dependent unless you’re paying at least half their support (food, clothing, shelter etc.) If your child is paying for living expenses with money from an account in their name, you’re no longer supporting them.

But losing them as a dependent may be a good thing – because it allows them to apply for the tuition deduction based on their income, not yours. So if the child’s account owes any tax on capital gains, you’ll be able to offset those with the deduction for tuition expenses. You may want to calculate the returns both ways – with or without your child as a dependent – to see which one provides the bigger tax savings.

You should also look into what’s called a Hope tax credit, which is worth up to $1,500 per student. Here again, there are restrictions: your “modified adjusted gross income” is capped at $52,000 ($105,000 for couples) and you can only take this credit for the first two years of college. (You’re also out of luck if the student has a felony drug conviction.) There’s also something called a “lifetime learning credit” – worth up to $2,000 a year per student -- which you may be eligible for.

For more on tax credits and deductions for college costs, check out Publication 970 on the IRS Web site.

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