Coverdell Education Savings Accounts

Coverdell Education Savings Accounts seem to go by many names today - Coverdell ESA, Coverdell IRA, even Coverdale IRA (for those that are not too sure of the spelling).  Some people might even recognize this name as the replacement for the Education IRA established back in 1997.

Coverdell ESA or 529 Plan

Whatever the name it goes by, a Coverdell can be an excellent way to save for college and they can even help you to avoid paying off those college loans in your retirement years.

Now some of you may be thinking that the 529 Plan is the best investment plan to pay for school, and that may be true for people trying to play catch-up, or those having a windfall to put into a college savings account.  But Coverdell Education Savings Accounts are another great way to start a nest egg for those little ones you hope to send off to college one day.

Similarities - Coverdell ESAs and 529 Plans

In fact, there are quite a few similarities between Coverdell ESAs and 529 plans including:

• Tax-advantaged if the money is used to pay for higher education expenses.
• Custodians of the account have flexibility in choosing the beneficiary.
• Money in both plans is considered the beneficiary's money when applying for federal financial aid.  This could lower the amount of student aid they receive.

Differences - Coverdell ESA and 529 Plans

There are also some important differences you should be aware of before choosing between a Coverdell ESA and a 529 plan:

• Contribution limits for Coverdell ESAs are much lower than 529 plans.  While the contribution limit is almost unlimited for 529 plans, Coverdell's are limited to a couple of thousand dollars - more on that later.
• Coverdell ESAs offer investors a much broader range of investment options when compared to most 529 plans - especially state run plans.
• Coverdell ESAs offer greater flexibility in terms of how the money is used.  For example, Coverdell ESAs can be used to pay for expenses of qualified elementary and secondary schools.
• 529 plans do not have age limits on beneficiaries, while Coverdell ESAs must be used or rolled-over to another beneficiary by age 30.

Coverdell ESA Contribution Limits

The new annual contribution limit for each child that you establish a Coverdell Education Savings Account was increased to $2,000 per beneficiary several years ago.  This was a substantial increase from the Education IRA's $500 limit.  In addition, the income limit for making a maximum contribution now stands at $190,000 for married couples filing joint tax returns, and contributions phase out at $220,000 in 2007 and 2008.  For those not filing a joint return, the contribution limit is $110,000.

Anyone can establish a Coverdell for a child / beneficiary and there can be multiple savings accounts established for the same child as long as the $2,000 annual limit is maintained - the total of all accounts.

Coverdell ESA Tax Implications

The contributions to a Coverdell ESA are not tax deductible, but money deposited in the account will grow tax-free until distributions are taken.  If the distribution from an account is not more than the beneficiary's qualified education expenses, then the beneficiary will not owe federal income tax on the distributions. Eligible educational institutions can be either postsecondary schools or an eligible elementary or secondary school.

This would include any college, university, vocational school, or other postsecondary educational institution that is eligible to participate in a student aid program administered by the Department of Education.  This would also include virtually all accredited, public and nonprofit postsecondary institutions. If you are not sure if the educational institution is qualified, then speak to someone in their financial aid office.

Coverdell ESA Beneficiary Rules

The annual contribution limit for 2007 and 2008 is $2,000 for each beneficiary, regardless of how many individuals contribute to the account.  Right now, there do not appear to be any plans to increase this contribution limit in the years 2009 and beyond.

And unless the beneficiary is a special needs student, then contributions cannot be made into the account after the beneficiary reaches age 18.  The balance of the account must be distributed within 30 days after the beneficiary reaches the age of 30, once again, unless the beneficiary is a special needs student.

Coverdell Rollovers

One way of avoiding taking an unwanted distribution is to take advantage of the rollover provision for Coverdell ESAs.  Distributed amounts are not subject to federal income taxes if they are rolled-over to another ESA for the benefit of the same beneficiary or a member of the beneficiary's family that is under the age of 30 including:

• A son or daughter or descendant of a son or daughter.
• Stepsons, stepdaughters, brothers, sisters, stepbrothers, or stepsisters.
• Father or mother or an ancestor of the father or mother.
• Stepfather or stepmother.
• Son or daughter of a brother or sister - nieces and nephews.
• Brother or sister of father or mother - aunts and uncles.
• Son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law.
• The spouse of any the individuals listed above.
• First cousins

Value of the Coverdell ESA

To summarize, Coverdell accounts offer individuals a simple savings mechanism for future education expenses.  Now $2,000 a year might not sound like much, but if even if we assume that this limit is never increased - which is unlikely - if you could put the maximum away each year for a child starting at birth at 6%, then you would have over $60,000 when that child reaches age 18.  That's a great start on those college expenses!

So you can call them a Coverdell IRA, or even Coverdale IRAs, by any name they are a serious college investment opportunity that is worth exploring.

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