Through the American Opportunity Credit, parents or students can receive a tax credit when paying for qualified college expenses, such as tuition and school supplies that are required for enrollment. An individual retirement account does allow you to take withdrawals for educational expenses, but using this money to qualify for the college tax credit may not be the smartest move.
College Tax Credits
The tax credit applies to the person responsible for paying the tuition. If you're paying your child's college tuition, you can qualify for up to a $2,500 tax credit, based on a dollar-for-dollar matching. For example, if you paid $5,000 in college tuition and expenses for the year, you'll qualify for the full amount, but if you only pay $1,000 in tuition and expenses, you'll only receive a $1,000 credit. At the time of publication, this credit applies through the tax year 2012. It is not clear whether it will be extended in the future.
Qualifying for the College Tax Credit
The American Opportunity Credit is only for taxpayers earning less than $80,000 per year ($160,000 for those who are married filing jointly). Additionally, the expenses you pay must be "qualified" expenses, which include tuition and course expenses, but do not include things such as room and board, transportation costs and health insurance costs.
Early IRA Withdrawals
An IRA is meant as a tool for saving for retirement. However, you are allowed to take withdrawals for certain expenses, including paying for college. Note, though, that while you are allowed to pay for room and board with funds from your IRA, this spending does not count toward the tax credit. If you have a traditional IRA, you will need to pay taxes on the amount of money you withdraw from your account, but you do not have to do this if you are withdrawing money from a Roth IRA. Your deposits to an IRA will only qualify for the tax credit if you spend them that year.
IRA vs. 529
Though it's possible to deposit and withdraw funds from an IRA to pay for college tuition and qualify for the tuition tax credit, this isn't the smartest move. Once you withdraw that money from your IRA, you cannot put it back, meaning that you lose out on potential earnings. Additionally, withdrawing it means you lose the tax benefits. A 529 plan, on the other hand, is similar to an IRA except that the funds are meant to be used for college expenses and are tax-free. If you're going to deposit money for your child's tuition into a savings plan, consider a 529 plan over an IRA.
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