Coverdell Education Savings Accounts
Always Plan Ahead
With the ever-ballooning costs of undergraduate and graduate college tuition, parents and children are now engaged in a race to savings from kindergarten age onwards through high school graduation (preschool spending does not qualify). In the spirit of putting away as much money as possible for a child’s future with as many benefits as possible like tax-deduction and interest earned, savings accounts for education are all the rage. Educational savings accounts or ESAs have become the popular kids among college savings plans, ploys and tools geared toward earnest parents and guardians of the future college students of the world.
While 529 plans with their flexible withdrawal and contribution options are widely marketed by every state in the nation as the premier college savings tool, the Coverdell Education Savings Accounts remain a bit more elusive, misunderstood and are frankly just not very well marketed. They are not given the credit or merit they deserve for savings accounts with such comprehensive coverage.
Here is your chance to learn a little more about the specifics and features of the Coverdell, and determine on your own if one of these ESAs is right for your financial situation and saving habits for your investment in your student.
The Horse Before the Cart Account
What makes the Coverdell distinctive from its 529 brethren is its ability to help families save for elementary, middle and high school in addition to college. This is perhaps one of the biggest perks and unique facets of the Coverdell.
When everyone else has gotten stuck in the college saving milieu, there is a government sanctioned savings account that will help those who are still trying to balance the family books for their kids’ primary education. With the increase of private expensive kindergartens, elementary schools, and prep schools, the Coverdell is more and more appropriate for families thinking of eduction expenses prior to college.
How the Coverdell ESA Works
As you know, the purpose of any savings account is to put money away for a rainy day, and in this case, a rainy day at school. The Coverdell works like any other savings account, but your money is not subject to federal taxation as long as it is used for its intended purpose of educational expenses.
A lending institution manages your Coverdell account for you just like any other account and makes sure you understand the nuances of the program since it is specifically targeted towards education only. There are stipulations you must agree to, including maximum contribution limits, a cut off for any and all contributions, and a use-by date by which the student must have transferred the money to the educational institution they will attend.
Any financial investment firm and most banks are able to open your Coverdell ESA for you and apply your contributions in a manner similar to an IRA. See the relevant IRS resource for more information on applying, and then get in touch with your personal banker or financial institution of choice to see if they offer Coverdell accounts and how to go about creating one.
Many financial gurus liken the Coverdell ESA to an IRA in its characteristics. This similarity stems from the fact that you have an annual maximum contribution before you are penalized. Currently, the maximum you can apply to the Coverdell is $2,000 per year, which according to past Coverdell history is extremely generous.
Be aware that this can change with the vicissitudes of Federal legislation. If you slip up and go over the limit, you are hit with a fee, of course, which is about 6 percent. Take care to not let this feature get the better of you by keeping careful tabs on the contributions you make throughout the year.
The confusing aspect of this feature is that other people can contribute to the account, like grandparents or friends, which means you really want to make sure you stay on top of any contributions outside your own since the penalties apply to the total contributions, not who made them. Staying organized and being diligent about tracking your input to the Coverdell account can eliminate any fees or frustration that might accompany this unique characteristic.
While your maximum contribution is $2,000 per year, you cannot contribute any more funds after your child, usually referred to as the account benefactor, is 18. This is because 18 is the age at which a child is legally concerned, for most purposes in the US, an adult.
With this in mind, take care to save wisely and make a plan for spending the funds, especially if you are using the ESA for primary and secondary educational expenses as well as planning on it serving your college needs. Make sure each dollar in the Coverdell account has an intended purpose and goes there as soon as it comes to the appropriate time in the benefactor’s life.
Life of the Coverdell ESA
The ESA lifespan lasts up until your child turns 30, so 12 years. If at this point there are leftover funds in the account or if none of it was used for college, they all revert to your child, who essentially is the owner of the account.
Be aware that whatever you contribute you will not get back, and that the funds may transfer over to your child if a plan is not in place to use them in time for their appropriate purpose. Also, you will want to be conscious of the fact that whatever funds are leftover will be subject to Federal tax laws once they are withdrawn, since they are no longer part of the ESA.
Getting Past the Limits
If you’re concerned about the above limits, such as yearly contribution and age factor, imposed by the Coverdell, consider your options and think about how the restrictions will or will not truly affect you. If you’re worried about not having enough tax-free money for college alone, you can also contribute to a 529 Savings Plan simultaneously in combination with the Coverdell.
In this way, you don’t have to stress over the maximum contribution rate or struggle to make sure you have enough saved in your Coverdell to cover college expenses, as well as education prior to university. Coverdell could be used only as your benefactor’s high school fund, for instance, while you have an entirely separate account for college.
If you have the financial capability and the future benefactor, ESAs make the most sense of all the ways you can choose to save for college. If you know how to use these accounts to your advantage by weighing their pros and cons closely with your own monetary habits and needs, you may decide that both a Coverdell and a 529 plan are right for you.
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