Sure, you want your kids to have the best college education, but can you afford it? Uncle Sam may be able to help.
Among the various tax-favored college payment plans is the Coverdell education savings account, previously known as an education IRA. When the account was renamed, it was also revamped, and Coverdell accounts now earn a better grade from taxpayers who are looking to stash cash for children’s schooling.
Up to $2,000 can be contributed to a Coverdell account (it was $500 in its earlier IRA incarnation).
Plus, you have more time to put the money in, can pay for more types of education expenses with the money and can combine Coverdell cash with other education tax breaks.
The basic account setup remains. While adults contribute to the savings plan, a child age 17 or younger is named as the account’s beneficiary. The contributions aren’t tax-deductible, but they and their earnings can be withdrawn tax-free as long as they are used to pay eligible schooling costs.
But that’s where the similarity between the old education IRA and the new Coverdell plan (renamed in honor of the late U.S. Sen. Paul Coverdell of Georgia) ends.
In addition to the increased $2,000 contribution limit, the Internal Revenue Service now allows several benefits.
OK, you’ve determined that a Coverdell education savings account is a worthwhile component of your child’s overall educational savings plan. So where do you put the money?
Any financial institution (a bank, investment company, brokerage, etc.) that handles traditional IRAs can help you set up and manage a Coverdell account. You can put your contributions into any qualifying investment vehicle — stocks, bonds, mutual funds, certificates of deposit — offered at the institution that will serve as the account’s custodian.
If you want to diversify, you can split the money up into several investments. There’s no limit on the number of Coverdell accounts that you can establish for a child. The only limit is on the total contributions: You can’t put more than $2,000 a year away for the student, regardless of how many accounts he or she has. Just be sure that management fees for multiple accounts don’t eat into your overall savings return.
If Junior decides college is not really for him, what happens to any unused education IRA money diligently contributed all these years? Then Junior pays the price when he turns 30. He must take any balance in the account within 30 days of his 30th birthday, and he’ll owe tax on the earnings plus a 10-percent penalty.
The IRS, however, offers a way out of this taxable situation. Junior can rollover the full balance to another Coverdell plan for another family member. This could be a younger sibling, niece, nephew or even his own son or daughter.
For more information on education IRAs and other education tax breaks, check out IRS Publication 970, Tax Benefits for Education.