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Ask Dr. Don
By
Don
Taylor,
Ph.D.,
CFA
•
Bankrate.com |
Investing for children's education
Dear Dr. Don,
I am trying to start an Education IRA for my two
kids, but I don't know who to go to.
Margie Matriculate
Dear Margie,
You have a tremendous amount of flexibility when investing in Coverdell
Education Savings Accounts, which is what the education IRAs are
now called. You can use certificates of deposit at your financial
institution, invest in mutual funds or set up a brokerage account
to invest these funds. You would want to set up separate accounts
for each of the children.
There's an annual total contribution limit of $2,000
per child and the ability to contribute is phased out for contributors
with high adjusted gross incomes. IRS Publication
970, Tax Benefits for Education, has much more on the topic,
including the FAQ table shown below:
| Question |
Answer |
| What is a Coverdell ESA? |
A savings account that is set up to pay the qualified education
expenses of a designated beneficiary. |
| Where can it be established? |
It can be opened in the United States at any bank or other
IRS-approved entity that offers Coverdell ESAs. |
| Who can have a Coverdell ESA? |
Any beneficiary who is under age 18 or is a special-needs
beneficiary. |
| Who can contribute to a Coverdell ESA? |
Generally, any individual (including the beneficiary) whose
modified adjusted gross income for the year is less than $110,000
($220,000 in the case of a joint return). |
| Are distributions tax free? |
Yes, if the distributions are not more than the beneficiary's
adjusted qualifed education expenses for the year. |
When deciding between mutual funds, brokerage accounts
and bank deposits, make sure the provider explains the annual fees
and expenses associated with the account, including sales loads
or commissions. If the account earns a $25 return this year and
you pay a $25 annual account fee, then you don't have much to show
for your investment. Savingforcollege.com
has a guide to Coverdell ESAs that is also recommended reading before
you take the plunge and invest for your children's future.
If you're putting aside a small amount on a regular basis, you
should also consider using savings bonds in the Savings
Bonds for Education program. The savings bonds would be held
in your name and, assuming you met the income requirements of this
program, the investment earnings would be tax-free when used for
qualified education expenses. This option gives you a little more
financial flexibility if you're not sure whether you'll need
this money down the road for something other than your children's
education.
Because you have that flexibility, you may be willing
to invest more in savings bonds than you would in a Coverdell ESA.
There is, however, a minimum holding period of one year and an interest
penalty (three months' earnings) for early redemption in the first
five years that you own the bonds.
Finally, don't forget to take a look at the Section
529 college savings plans too. A prepaid tuition plan or college
savings plan may be a better fit than Coverdell accounts for your
children. That's especially true if your contributions generate
a deduction on your state income taxes.
-- Posted: Jan. 23, 2004
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