Start saving now if you haven’t already

First, don’t feel bad if you’ve neglected to save as much as you wanted to help pay your child’s college tuition. It’s never too late to start saving. Every dollar saved is one that you or your child won’t need to borrow to pay those college bills.

You can also open a 529 college savings account while your son or daughter is still attending school.

Have the “talk”

Also, if you haven’t had the “talk” with your child, you should do so before he or she heads off to school. (In this case, the “talk” centers around the cost of college and who will be responsible for paying tuition and other expenses.)

If you need to borrow money to send your child to college, a good exercise is to fill out the Free Application for Federal Student Aid (FAFSA) together. This will help your child understand how much is being borrowed, what the interest rate on the loan will be, and when payments will begin. It will also give you an opportunity to discuss what portion, if any, of the college costs you’ll be paying.

Knowing just how much of the cost you’re willing to cover may impact your child’s college decision.

Set expectations

Before your child makes a decision on which college to attend, talk about the costs involved with each school. While attending a private out-of-state school might be preferable, consider whether the benefits of attending that school outweigh the added costs compared with attending a public in-state institution.

Bottom line: Selecting a school should be centered on giving your child the best chance for success. If your child’s preferred school offers a marginally better education but will saddle your son or daughter with a mountain of debt, it may not be worth the added burden.

Avoid the grandparent trap

Maybe your child’s grandparents have also been saving in a 529 plan. If you’re not careful, their generous gift could reduce the amount of financial aid that your child receives.

Students submit the FAFSA application before each school year begins. As long as money stays in a grandparent’s 529 account, it doesn’t need to be reported on the FAFSA. But when a grandparent withdraws money from a 529 account and uses it to pay for your child’s college expenses, your child must report the money as income on next year’s form.1

To avoid increasing his or her income and possibly decreasing the amount of aid awarded, your child should consider waiting until the year in which he or she files the final FAFSA to use a grandparent’s 529 account to pay for college.

If your child expects to graduate in four years, he or she may use a grandparent’s 529 money as early as the second semester of junior year, provided the grandparent makes the withdrawal on or after January 1.2

Your child’s grandparent can also pay the school directly (on the child’s behalf). If the money is paid directly to the school, your child won’t have to claim it on the FAFSA application.

Do a little homework

With a little foresight, you might be able to qualify for up to $2,500 through the American Opportunity Tax Credit (AOTC). To get the maximum credit, plan to cover $4,000 in qualified expenses (including tuition and course materials, etc.) from sources other than your 529 account, like a checking or savings account or student loans.

If $4,000 is too much, remember that the AOTC applies to 100% of the first $2,000 of qualified expenses (and to 25% of the next $2,000), so you can receive a $2,000 credit by paying $2,000 of your child’s qualified expenses out-of-pocket.

The credit represents a dollar-for-dollar reduction of your federal tax bill, so if you qualify for the full $2,500, your tax bill will be reduced by that amount—and if your tax bill is less than the amount of your credit, you’ll qualify for a refund of up to $1,000. It applies per student, so you might be eligible for two or more American opportunity credits in the same year. The credit phases out for couples filing jointly with a modified adjusted gross income (MAGI) of $180,000 and for single filers with a MAGI of $90,000.3

If you’re qualified to take advantage of the credit, pay careful attention to how much money you withdraw from your 529 account. If, for example, your daughter’s tuition costs $10,000 and you plan to pay $4,000 from your savings, make sure to withdraw only $6,000 from your 529 account. If you withdraw the full $10,000 from your 529 account and then claim the credit too, the earnings portion of the “extra” $4,000 would be counted as income and subject to a 10% penalty.

Tax matters can be tricky. You may qualify for a tax credit other than the AOTC. We’d suggest talking with a tax advisor if you have questions about your individual situation.

1AnnaMaria Andriotis. “When Grandparents and 529 Plans for College Savings Clash.” The Wall Street Journal, August 22, 2014.
2“When Grandparents and 529 Plans for College Savings Clash.”
3IRS Publication 970 (2015): Tax Benefits for Education