personal finance  |  september 22, 2023

The Important Tax Advantages You Should Consider When Paying for College

A coordinated plan to tackle the costs of college can provide you with peace of mind as your child marches toward graduation.


Key Insights

  • Grants and scholarships are generally tax-free as long as certain conditions are met.

  • A 529 college savings plan goes beyond tuition and fees and extends to covering expenses related to room and board.

  • A 529 account isn’t limited to colleges within your state.

  • Some tax credits such as the American Opportunity Tax Credit and the Lifetime Learning Tax Credit have income restrictions, so it’s important to know if you qualify.

  • The interest on federal student loans may be tax-deductible.

Judith Ward, CFP®

Thought Leadership Director

Paying for college is a substantial investment in the future of our children. The average published total cost for four years at a public, in-state institution was about $93,000—and at private colleges, around $213,720—according to the College Board’s Trends in College Pricing 2022. Families may find that a combination of savings, income, and loans are needed to fully fund a child’s college experience. Each of these sources has tax benefits that are important for you to know.

A coordinated plan to tackle the costs of college can provide you with peace of mind as your child marches toward graduation.

Grants and Scholarships

It is very beneficial for your child to explore all grant and scholarship possibilities as they don’t need to be paid back. Typically, the term “grant” refers to need-based financial aid, whereas scholarships are usually based on merit. Grants and scholarships could cover about 29% of college costs, according to Sallie Mae’s How America Pays for College 2023.

Generally, this money is tax-free as long as certain conditions are met:

  • The student must be in a degree or vocational program.

  • The money is going toward qualified education expenses, including tuition and course-related expenses, such as fees, books, and supplies. (Note: Room and board is not considered a qualified education expense.)

529 Education Savings Plans

You may be aware of 529 education savings plans. These accounts are a great way to save for your child’s college education because of the potential tax benefits. Important tips to know include:

  • Any growth of the money you save in a 529 education savings account is tax-deferred.

  • Distributions are tax-free when used for qualified education expenses. Qualified education expenses go beyond tuition and related fees and include room and board, which could be as much as—or more than—tuition.

  • You may receive a state income tax deduction or other state tax benefits for your contributions.

Keep in mind that you can use your 529 account savings to pay for the costs of any federally accredited college or technical or trade school, as well as certified apprenticeships, and aren’t limited to within your state. Additionally, the savings can be used for education loan repayments up to a $10,000 lifetime maximum per beneficiary.

Saving in a 529 account has relatively little impact on financial aid eligibility if the account is held in a parent’s name (with the child as the beneficiary). Using a 529 account is a good way to reduce reliance on loans.

If all of the funds aren’t needed to pay for undergraduate school, they can be used for graduate school or transferred to another family member.

Tax Credits and Deductions

A tax credit, such as the American Opportunity Tax Credit and Lifetime Learning Tax Credit, reduces your tax bill dollar for dollar. A tax deduction reduces your taxable income by the amount you contribute, usually up to a specified dollar figure. They each have different benefits and may be helpful if using regular savings or income to pay for college costs while the child is enrolled.

No double dipping! Wouldn’t it be great if we could take a tax-free distribution from our 529 account and then claim a tax credit for college expenses? Of course it would be—but it’s not allowed. You can’t take more than one education tax benefit for the same student and the same expenses.

Each 529 plan may have different state tax benefits available for its account holders. It’s important to have a coordinated strategy and consider which option(s) might provide the best tax advantage for you.

Tax Credits and Benefits
Tax Credit*
Annual Benefit**
Highest Income Eligible
American Opportunity Tax Credit Federal income tax credit up to $2,500 per eligible student, per year. Can be claimed for only four tax years of postsecondary education for qualified expenses such as tuition and course-related books, supplies, and equipment. The credit is refundable, meaning if the credit pays your tax down to zero, you can have 40% of the remaining amount of the credit (up to $1,000) refunded to you. Modified adjusted gross income (MAGI) is less than $90,000 for single filers, $180,000 for joint filers.
Lifetime Learning Tax Credit Federal income tax credit up to $2,000 per tax return. No limit on the number of years you can claim the credit for qualified tuition and related expenses. The credit is not refundable. MAGI is less than $90,000 for single filers, $180,000 for joint filers.

*Tax credit and deduction information per IRS 2022 Publication 970.
**Tax-free grants and scholarships may reduce qualified education expenses.

Student Loans

Many college kids today are graduating with student loan debt. According to the College Board, 54% of bachelor’s degree recipients from public and private nonprofit four-year institutions graduated with student loan debt in 2020–2021. The average debt was about $29,100. That’s a payment of about $250 to $300 a month over a 10-year term.

Starting out in debt is certainly not ideal; however, it may take a small loan amount to help fund college. If possible, limit debt to federal student loans and stay away from private loans. Federal loans offer more consumer protection and flexible repayment options.

When paying back these loans, the interest may be tax-deductible up to $2,500 if the MAGI is less than $85,000 for single filers or $175,000 for joint filers. You can claim this deduction even if you don’t typically itemize deductions.

Multiple Sources, Multiple Benefits

While this is by no means an exhaustive list with every conditional detail included, it’s certainly a start. It usually takes multiple resources to invest in your child’s future. Understanding these benefits may help make the cost of college more manageable.

Please note that a 529 plan’s disclosure document includes investment objectives, risks, fees, expenses, and other information that you should read and consider carefully before investing. You should compare these plans with any 529 college savings plans offered by your home state or your beneficiary’s home state. Before investing, consider any tax or other state benefits, such as financial aid, scholarship funds, and protection from creditors that are only available for investments in the home state’s plan. Tax benefits may be conditioned on meeting certain requirements, such as residency, purpose for or timing of distributions, or other factors, as applicable.

Important Information

This material has been prepared by T. Rowe Price for general and educational purposes only. This material does not provide recommendations concerning investments, investment strategies, or account types. It is not individualized to the needs of any specific investor and is not intended to suggest that any particular investment action is appropriate for you, nor is it intended to serve as the primary basis for investment decision-making. T. Rowe Price, its affiliates, and its associates do not provide legal or tax advice. Any tax-related discussion contained in this material, including any attachments/links, is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding any tax penalties or (ii) promoting, marketing, or recommending to any other party any transaction or matter addressed herein. Please consult your independent legal counsel and/or tax professional regarding any legal or tax issues raised in this material.

All investments are subject to market risk, including the possible loss of principal.

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Next Steps

  • Access college savings tools and resources.

  • Contact a Financial Consultant at 1-800-401-1819.