If your income isn't as high: Weigh tax breaks
If your MAGI is below the $90,000 or $180,000 threshold, you might qualify for a tax break called the American Opportunity Tax Credit (AOTC). Or you might be able to deduct up to $4,000 in tuition and fees on your tax return. But you can't claim both benefits for the same student in the same year.
The AOTC is a credit subtracted directly from your taxes. Claiming it can cut your taxes by up to $2,500 per student a year. In contrast, the tuition-and-fees deduction will cut your adjusted gross income by up to $4,000 a year; if you're in the 25 percent bracket, you could save $1,000. Tax software will automatically select the better option for you. "Most programs indicate that the AOTC will reduce your tax bill by more than the tuition-and-fees deduction," says Deborah Fox, who heads Fox College Funding, a planning firm in San Diego.
But tax software doesn't take into account the fact that claiming the tuition-and-fees deduction might enable your child to qualify for more need-based financial aid, Fox says. Deciding which break works best might require running the numbers with a financial adviser. Keep in mind that you can't claim tax breaks for the same expenses you cover with 529 withdrawals. If you do, some earnings from the 529 will be considered "nonqualified"–that is, taxable.
If you have multiple 529 plans: Manage withdrawals
When there's more than one 529 plan for the same student, withdraw from the account with the highest returns first. You'll realize larger tax-free gains.
Accounts owned by grandparents don't have to be listed as an asset on the FAFSA, which can help the grandchild qualify for more student aid, notes Mark Kantrowitz, publisher of Edvisors.com, a network of websites about planning and paying for college. The catch? Paying college bills from a grandparent-owned 529 can reduce financial aid eligibility by as much as half of the amount taken from the account.
Kantrowitz suggests changing the account ownership from the grandparent to the parent or student, a move allowed by most states. The shift will affect financial aid eligibility a little, he says, but much less than if the grandparent's 529 plan paid the college bills. Or, he says, wait to take distributions from the grandparent's account until after the FAFSA is filed for the senior year in college, when you no longer have to file future FAFSA applications.
Hurley has a different take. He favors using money from the grandparent's 529 account sooner than later to pay college bills. "It is generally best to use other people's money before you lose it," he says.