It’s never too early to think about your child’s goals for financial security and education. That little one will grow up and be ready to apply for college and begin a career before you know it. So how do you give your child a jump-start on financial security? New and previously-existing tax rules include provisions that can help.
One or more of these six tax provisions could be part of achieving your child’s goals for financial security and education:
- “Kiddie Tax” – The “kiddie tax” generally applies to unearned income of children under the age of 19 (or under age 24 for full-time students). Before 2018, unearned income was generally taxed at the parents’ tax rate. Under the 2017 Tax Cuts and Jobs Act (TCJA), children’s unearned income is taxed using the lower tax brackets used for estates and trusts.
- IRAs for Teens – IRAs are perfect for teenagers with earned income because they will have many years to let their accounts grow tax-deferred or tax-free. Choosing a Roth IRA typically provides a better long term advantage for teenagers, who are not likely to derive a tax benefit from a traditional IRA due to their typically low income level.
- 529 Plans – Section 529 plans provide valuable tax-advantage savings opportunities for students. Contributions are not tax deductible for federal purposes, but growth is tax-deferred and distributions are tax-free if used for qualified education expenses. Under the TCJA, 529 plans can be used for K-12 tuition and qualified fees, up to $10,000 per year.
- Coverdell Education Savings Accounts – Like the 529 plans, contributions are not tax deductible for federal purposes, assets grow tax-deferred and distributions used to pay qualified education expenses are tax-free. Coverdell plans can be used for K-12 expenses for tuition, fees and other qualified expenses. Unlike 529 plans, Coverdell plan contributions are subject to income limitations.
- Achieving a Better Life Experience (ABLE) Accounts – ABLE accounts offer a tax-advantaged way to fund qualified disability expenses for a beneficiary who became disabled or blind before age 26. Under the TCJA, 529 education plan funds can be rolled over to an ABLE account without penalty. The rolled-over amounts count toward the overall ABLE account annual contribution limit, which is $15,000 for 2019.
- American Opportunity Credit (AOC) – The maximum credit per student is $2,500 per year for the first four years of postsecondary education, subject to income limitations. Both the AOTC and a distribution from either a 529 or Coverdell plan can be taken in the same year as long as the same qualified education expenses are used for both.
Get a jump-start on achieving your child’s goals for financial security and education with one or more of these six provisions in the 2017 TCJA and previously-existing tax rules. The time for filling out college applications is closer than you think.