Strategies for Paying College Bills

For families with college students, the end of summer usually signals the time to move your student—and bring out the checkbook to pay a giant tuition bill. When deciding which accounts to tap for college costs, it's important to keep some key rules in mind so you don’t jeopardize possible tax breaks.

Last year's economic stimulus plan created the American Opportunity Credit for 2009 and 2010, which is more valuable than the Hope credit of previous years and applies to more people. To qualify for the American Opportunity Credit, your adjusted gross income must be less than $90,000 if single or $180,000 if married filing jointly.

Money you spend on tuition, fees and course materials, such as books, in the first four years of college can count toward the American Opportunity Credit, which can lower your tax bill by up to $2,500. The actual calculation for the credit is 100 percent of the first $2,000 you pay for eligible expenses, plus 25 percent of the next $2,000 of eligible expenses.

But you don’t get this break if you pay all of the bills with money you saved in a tax-favored college saving plan, such as a 529 plan or Coverdell. That would be double dipping. The “good” news is that most colleges cost enough that you’ll easily be able to spend $4,000 of non-tax-favored funds to capture the full American Opportunity Credit, then use your 529 and Coverdell money for other expenses. You can even use the 529 to buy a computer or Internet access for your college student this year.