Coverdell Education Savings Accounts

You can use the Coverdell Education Savings Account (ESA) to help pay for your child’s elementary and secondary school expenses, as well as college expenses. The annual contribution limit is $2,000, but keep in mind that income limits apply. (Refer to the chart on page 11.) You have until the April tax filing deadline in 2022 to make contributions for 2021. Grandparents and other family members may also make contributions for your children, as can corporations and other entities. There is no limit to the number of accounts that can be held in a child’s name or the number of people who may make contributions to a Coverdell ESA—as long as total contributions remain within the $2,000 annual limit per child.

Funds withdrawn from an ESA (both contributions and earnings) are tax free if used to pay for qualified expenses. However, tax-free distributions are not allowed if an education tax credit is used for the same expenses for the same student. The beneficiary must use ESA funds by age 30. If not, the account may be transferred to a relative.

Education Bonds

Education Bonds offer tax-free interest on Series EE bonds issued after December 31, 1989, and all Series I bonds. Tuition and fees are qualified expenses. You can rollover an education bond into a 529 Plan or Coverdell ESA. Income phase-out’s for 2021 are $83,200-$98,200 for single and head of household filers and $124,800–$154,800 for married filing jointly. Some important notes: income limits apply when bonds are cashed; bonds must be in the parent’s name; the child must be the beneficiary, not co-owner; and the purchaser must be age 24 or older.

Education Tax Credits

If you are currently paying higher education expenses, two Federal tax credits may help lessen your tax bill: the American Opportunity Tax Credit and the Lifetime Learning Credit.

The American Opportunity Tax Credit is worth $2,500 in 2021. It is now available for all four years of college, and it can be used to cover the cost of course materials. Income phase-out levels for the credit begin at $160,001 of modified AGI for joint filers and $80,001 of modified AGI for single filers in 2021. In addition, 40% of the credit is refundable, which could enable lower-income taxpayers to get money back from the IRS.

The Lifetime Learning Credit, which applies to undergraduate study, as well as graduate and professional education pursuits, could be worth up to $2,000. The Consolidated Appropriations Act (CAA) of 2021 changed the Lifetime Learning Credit by aligning its income phase out rule with the American Opportunity Tax Credit. For 2021, eligibility begins phasing out for joint filers with modified AGI above $160,000 ($80,000 for single filers). If a student qualifies for both credits in the same year, you may claim either credit, but not both.

If you cannot claim either credit because your income is too high, your child can take the full credit if he or she has sufficient taxable income. However, you will not be able to claim a dependency exemption for the child. Your savings, therefore, will be the amount of the credit less the tax benefit of the lost dependency exemption. But, be aware that, based on your income, the exemption may be reduced.

Other Education Benefits

Those who have student loans forgiven may not have to pay tax on the waived debt if they work in public service jobs or teach in schools in low-income areas for 120 months, and make regular loan payments during that time. This rule applies to loans first made by the government or by private lenders that are later consolidated into Federal loans. Information on Federal loan forgiveness programs can be found at studentaid.ed.gov.
Tax Benefit	Maximum Benefit	Qualified Expenses	2021 Income Phaseouts	Notes
Student Loan Interest Deduction	$2,500 above-the-line deduction	Student loan interest	Single and Head of Household $70,000–$85,000 Married, Filing Jointly $140,000–$170,000	Person obligated to make loan payment must be/have been at least half-time student in degree program
Employer Tuition Assistance	$5,250 exclusion from income per student	Tuition, fees, books, supplies, equipment	None
Scholarships	Excluded from income	Tuition, fees, books, supplies, equipment	None	Student must be degree candidate

You can withdraw from your IRA to pay qualified higher education expenses without being penalized. The amount withdrawn will be subject to taxation, however.