How to Tap College Savings

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How to Tap College Savings

If you want to take advantage of the American Opportunity tax credit this year, you can't use 529 plan money to pay all the college tuition bills.

My daughter will be starting college this fall and the tuition bill is due soon. What is the best way to coordinate our 529 savings plan with the new college tax credit?

Before you tap your 529 plan for this semester’s tuition bill, see whether you can take advantage of the American Opportunity credit, which provides a tax credit of up to $2,500 each year for eligible college costs paid in 2009 and 2010. You can’t double dip on tax breaks, so you won’t get this one if you pay all the college bills with money from a tax-favored college-savings plan, such as a 529 plan or a Coverdell education savings account.

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The American Opportunity Credit temporarily replaces the Hope credit, but the income limits are much higher -- your adjusted gross income must be less than $90,000 if you’re single or $180,000 if you’re married filing jointly. If you qualify, you can deduct from your tax bill 100% of the first $2,000 you pay for eligible expenses, plus 25% of the next $2,000 of eligible expenses. Money you spend on tuition, fees and books in the first four years of college can count toward the credit.

Most families won’t have a problem spending $4,000 on college expenses to capture the full American Opportunity credit, then using the 529 and Coverdell money for any remaining portion of the tuition bill, plus room and board. You can even use the 529 money to buy a computer and Internet access for your college student in 2010.

For more information about saving for college and paying the bills, see our Paying for College special report. For more details about the special tax breaks for college expenses, see IRS Publication 970.

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