$2000 Tax Break Coming for PC Purchases

If you're saving now to buy a computer for your child's education, Uncle Sam is going to make the hit a bit easier to take.

Thanks to the new tax plan, if you're a parent you'll soon be able to put four times as much money away each year in a tax-advantaged college education savings plan. And, for the first time, you can use that money for education-related expenses before your children reach college.

Today, parents can sock away just $500 per year in an Education IRA for kids under the age of 18. Next year, they'll be able to put $2000 per year in education savings accounts (ESAs).

You can only use ESAs to cover school-related expenses, but those expenses can include computers, educational software, and even Internet access. And starting in 2002, parents will be able to use ESAs to pay education expenses for kindergartners through 12th-graders. Your deposits into ESAs are not tax deductible, but your earnings on those contributions (which you can invest in stocks, bonds, and mutual funds) are free from tax.

School Savings Grow Tax-Free

"If you put $2000 in one year and wait a year and take it out, assuming 10 percent growth, you'd have $2200 to use for qualified expenses like a PC," says Ed O'Connor, director of retirement and education savings for Merrill Lynch. "You are not paying any tax on that, and you have an extra $200 that you didn't have in the past and that you don't pay taxes on."

The new tax plan also includes increases in the amount of higher education expenses that are tax deductible.

"There is a feature where you can deduct for qualified higher education expenses up to $3000 for 2002 and 2003. And, it [the deduction] grows to $4000 starting in 2004," O'Connor says. "Those expenses are separate and beyond what you pay from the Education IRA."

Education Savings Champion

Senator George Allen championed the ESA changes, which the freshman Virginia Republican managed to add as an amendment to the giant tax cut bill. (To estimate your own tax savings under the plan, see " How Big Is Your Slice of the Tax-Cut Pie?"

"It is unprecedented new ground gained for elementary and secondary school children in making home computers more affordable with such a tax deduction," Allen says. "Over the next ten years, these computer and education savings accounts will represent over $6.5 billion in new education spending."

Anyone, provided they meet the taxpayer guidelines, can contribute to an ESA, he says.

"What's also great about these computer and education savings accounts is that relatives can make contributions to them for anyone under 18," Allen says. "So grandparents, aunts and uncles, and in-laws can help parents put money away now to help their children buy a computer today, or in the future."

Who Qualifies?

There are income limitations for ESAs. Single taxpayers earning up to $110,000 can participate, as well as couples with no more than $160,000 in adjusted gross income. Anyone in a higher tax bracket won't be able to participate when the new rules go into effect next year.

The IRS Web site features ESA tips. It also links to a publication covering tax benefits for higher education, which includes information about tax-advantaged savings programs on the state level that can be used to pay education expenses.

If you can afford to contribute more than $2000 per year in an education savings plan, O'Connor recommends a close look at applicable state programs, which allow a couple to contribute up to $20,000 per year. Single taxpayers can contribute $10,000 per year. There are no tax deductions for the contributor, but earnings on the investments are tax-deferred until withdrawn and used by the student for educational expenses.

Because the student is likely to be in a lower tax bracket than the contributor, the taxes they pay when they need the money are also likely to be lower, O'Connor says.