Education Deduction Phaseouts Don’t Make Sense!

Education is a good thing right? So why is student loan interest deductibility phased out when your modified adjusted gross income reaches $65,000? Why are the Hope Credit and the Lifetime Learning Credit phased out if you make more than $57,000? And if your MAGI is greater than $80,000, you can’t deduct tuition and fees from your income. I think there’s a conspiracy by the government to keep rich people as ignorant as possible! Okay okay, I’m being facetious of course with the outlandish conclusion but I think it’s unfair that the phaseouts exist and I’ll explain.

I think higher income workers should be taxed more even though they don’t use more services. While “unfair,” I also think it’s totally acceptable, and preferable, that the government does a little income redistribution through income taxes. There’s no reason why people should go cold, hungry, or sick because they can’t afford heat, food, or medicine while other people are living in million dollar homes and driving hundred thousand dollar cars. We, as a society, should strive for better. While some wealthy people scoff at the thought of their hard work subsidizing someone else, I think there are fewer of those types of people than you would think. At some point in the last 200+ years, the vast majority of families showed up in the United States with nothing and needed a hand from someone.

That being said, I think that many of the income related phase outs make sense because they restrict a high income earner’s ability to take advantage of accounts designed to improve their financial situation. A single filer with a MAGI greater than $116,000 cannot contribute to a Roth IRA, which seems fair (unless you live in Manhattan, then $116k feels like it should qualify you for welfare!), and they are less affected by the loss of this great retirement savings vehicle.

What doesn’t make sense is that education is and should be different. I can understand not extending tax advantaged accounts to the wealthy because they don’t need any additional financial advantage, but why remove the incentive to educate? College is expensive! The Princeton Review estimates that the annual cost of a year’s tuition, room and board, and fees at a private school will be $33,303 in 2008 and at a public school it will be $12,514 in 2008. These aren’t $4,000 Roth IRA accounts here, we’re talking practically a minimum of $50,000 to send your child to an institution of higher learning.

If you see your life as a business, which is a good way of managing it, education is an expense and should be deductible against your income for everyone. If a company can deduct education expenses from its income, why can’t every single person?

Can someone explain why these phaseouts exist?

(For more information about the Tax Benefits for Education, refer to IRS Publication 970)


Take Advantage of Education Reimbursement

If your employer offers any tuition reimbursement and you’re not taking advantage of it, you’re leaving a tremendous amount of value on the table each year. In the two jobs I’ve had since graduating college in 2003, I’ve been lucky enough to be offered the opportunity to pursue higher education in return for sacrificing some of my time. At my first job, every educational dollar I spent was fully reimbursed (you were only allowed to take two classes a semester, or six a year) with no requirements afterwards. In my second job, I was afforded $5,000 a year with some continuation of work requirements. Through both programs I was able to get a majority of my MBA paid for (ooooh, an MBA!). In both cases, I took advantage of them to the fullest extent possible and if you have this opportunity, you should too.

Time on the Side of Youth

I can understand if you don’t take advantage of it because you have children to care for and a family to attend to, those are perfectly acceptable demands on your time. If you’re young and have an abundance of time and a limited amount of responsibility, you’re doing yourself a tremendous disservice by not taking advantage of this. After work each day, how do you spend your time? Do you spend it lounging in front of the television? Do you spend it drinking at the bar? Unless it’s volunteering or working towards a higher purpose, I would recommend swapping at least one night of drinking and lounging with a night of classes. After a couple years, you’ll have a degree instead of nothing (or a beer belly!). One night is not too much to ask in return for shifting your path.

Consider It Compensation

Give yourself a raise by taking these classes. In fact, when you’re done, you can take your more competitive resume out into the marketplace and give yourself a second raise. I took twelve classes at my first employer over the course of two years. Each class cost approximately $1,500, so I gave myself a $9,000 a raise onto my base pay each year. In my three years of working for that company, my salary when I left wasn’t even $9,000 higher than when I started! After you are awarded your degree, shop yourself around. Your job isn’t your girlfriend, you can date other jobs.

If your current employer has an attendance requirement, as in you have to stay in your job for a period of time or repay the tuition reimbursement, you can stay on until that’s fulfilled or you can ask prospective employers to give you a bonus for that amount. Good talent is extremely difficult to find, paying a few dollars more to get someone into the door is worth it for a business that’s seriously considering you.

Take Electives to Expand Your Horizons

Don’t want to commit yourself to a full blown degree? Not a problem, signing up for a full menu of classes may be too much for you right now. Consider taking a few electives in your spare time, electives that will expand your horizons and give you more breadth of understanding in your field. Oftentimes the full menu of classes for a degree contain classes that are too basic and broad. This is especially common in programs designed to generate revenue for a college (think part-time MBA!). Does an MBA student really need a remedial statistics class or a basic economics class? Taking electives should give you a laser-focused area of study that you will find immediately applicable.

Networking, Networking, Networking

While education is important, networking is more important. I had a friend whose brother went to an excellent school. It’s a top notch university that has an extensive history of extremely famous and accomplished alumni. My friend’s brother’s roommates were All-American athletes, the children of officers in the armed services or politicians, or ridiculously brilliant. Sure, the school was “tough” but there was a fair amount of grade inflation and a fair amount of intellectual and athletic competition. That institution is a little school in Boston, MA known as Harvard University. (true story, at least as told by my friend)

There are many reasons why you should take advantage of tuition reimbursement plans, I listed only a few. Many people don’t have the benefit of these programs and would give up a lot to be able to have their education partially paid for, please don’t squander the opportunity unless you have a very good reason.


Introduction to 529 Education Savings Plans

The key to being prepared is to learn about stuff before you need them and learning about 529, for me, certainly falls into that category! A 529 plan is an educational savings plan named after the section of the federal tax code that outlines the rules for them. Basically there are two types of 529 plans, prepaid tuition plans and college savings plans, but they are generally designed to help you save towards college for your children.

(Click to continue reading…)


Your Tax Return as a Subtle Financial Planner

I forget what show I was watching, but it was one of those shows where you have all that Bloomberg ticker crap taking up 75% of the screen and little faces jibber jabbering in the leftover space, but the guy talked briefly about how your IRS 1040 (the full incarnation of the form everyone fills out for taxes) gives you subtle reminders of the things you should do to help plan your financial future. I didn’t watch the whole thing but I thought it’d be fun to go through each relevant line (yeah, I’m a sadist) and see how it could be used as a subtle yearly financial plan reminder.

Line 8a – Taxable Interest
Line 8b – Tax-exempt Interest
There are investment vehicles out there that are tax exempt at certain government levels. For example, an EE/E bond is exempt from State and local income taxes but not from federal taxes. This is a reminder that sometimes your most conservative assets may be better placed in a tax-exempt bond than in a savings account bearing 3.0%. Of course, you sacrifice flexibility but you should know tax-exempt investments are out there but you do keep Uncle Sam’s grubby little paws off your loot.

Line 13 – Capital gain or (loss)
This is something you can only capitalize on if you remember it before December 31st. If you have a loss and want to write it off, sell it to offset a gain you may have had. Just remember not to repurchase shares in the same company within 31 days or the “wash” rule will bite you (and you won’t be able to write off the loss). Did you buy shares of JDS Uniphase and got burned badly in the bubble? Yeah, me too, write it off now because they’re never going to break even for you.

Line 15a – IRA distributions
Line 25 – IRA deduction
Contribute to a Roth or any other type of IRA? These lines are a reminder that perhaps you should be planning for your retirement because Social Security won’t be enough to sustain a lavish retirement lifestyle! 🙂 Retirement planning, especially for young workers, is critical because it is something that benefits with the passage of time. The more you sow now, the greater the benefits you will reap in the future. You want to be living in luxury when you’re retired, not a cardboard box. (You cannot deduct Roth contributions on your return, I just intended for that line to serve as a reminder to plan for retirement)

Line 33 – Penalty on early withdrawal of savings
Tsk tsk! That IRA or 401k isn’t a slush fund you can withdraw on to buy that shiny [whatever]. Let line 33 be a reminder that you will be penalized for mortgaging a portion of your retirement for gratification now. Alright, I’m just kidding about the severity but you should be readily dipping into your retirement for every thing. Sometimes it makes financial sense, but most (90%) of the time it’s a bad idea. (Example of good ideas? In times of hardship, dipping into the retirement savings may be unavoidable)

Line 49 – Education credits
The government will help you educate yourself, even if your employer will not. Learn about Hope Credit and Lifetime Learning Credits and see how you or your dependents may benefit from them.

Unless I’ve missed anything glaring, those 5 “lines” cover a lot of the basic financial planning advice given out these days. Consider all investment opportunities with respect to the tax advantages, plan for your future, don’t mess up your future by needlessly borrowing from it, and always educate yourself. I’m not saying that the dreaded tax form should be your financial advisor, a human being almost always beats a piece of paper, but it gives you a couple subtle reminders for things you may have forgotten or conveniently ignored. Take a look at your return and see if you’ve taken advantage of everything you could’ve.

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