How to Get the Most From Education Tax Breaks

Parents can save hundreds -- or even thousands -- of dollars on their tax bill if they know where to look for savings.

This is possible by taking part in tax-advantaged college savings plans, as well as tax breaks available for students.

College tuition and fees at public four-year institutions rose 6.6% last year, far outstripping inflation, according to the College Board. So it's important to take advantage of any education-related tax break for which you qualify -- both before your children enter college and after the tuition bills start rolling in.

529 Plans

Named after the relevant section of the Internal Revenue Code, these state-sponsored plans let parents, grandparents and others save for a child's college education in a tax-advantaged account. Investment maximums vary by plan but are typically $250,000 or more. And deposits receive favorable gift tax status.

Some 529s allow you to prepay college tuition now, at today's prices. Others are structured as investment accounts. The investment accounts offes greater flexibility than prepaid-tuition plans, because they don't commit students to a particular school or group of schools. These accounts can lose money if the underlying investments perform poorly, however.

Deposits in 529 college savings accounts are made with after-tax money, but the money can grow tax-free as long as withdrawals are used to pay for college costs -- including tuition, fees, books and equipment. What's more, funds in 529 plans are not held in the student's name, so the money isn't considered a student asset; that should help when it comes time to apply for financial aid.

Investing in your state's plan might qualify you for a state tax deduction. But you may find that other states offer lower fees or better investment selections, so it's important to investigate all of your options via sites such as CollegeSavings.org.

Coverdell Educational Savings Accounts

Parents of students younger than 18 can invest up to $2,000 per year in these accounts. Deposits are not tax-deductible, but earnings grow tax-free. Withdrawals for elementary, high school and college expenses are tax-free as well. Benefits are gradually phased out for individuals with taxable income between $48,000 and $58,000, and for married couples filing jointly with income between $94,000 and $114,000.

The Hope and Lifetime Learning Credits

The Hope credit provides a tax credit during two years of a qualified degree program: up to 100% of the first $1,200 of qualified education expenses you paid for the eligible student, and 50% of the next $1,200 (up to $1,650 per year). The Lifetime Learning Credit returns 20% of qualified education expenses over a student's lifetime (up to $2,000) for money spent on post-secondary education, and there's no limit to the number of years you can claim it.

Both credits are available to students of any age, and they are gradually phased out for individuals with taxable income between $48,000 and $58,000, or for married couples filing jointly with income of between $94,000 and $114,000. However, you can't take both credits for the same student in the same year. Use IRS Form 8863 for whichever credit you choose.