Often hidden in the shadow of its better-known sibling, the 529 plan, the Coverdell Account is a good, tax-free option for a college savings account. Although deposits are not tax exempt they grow tax-free if the funds are spent on school. Acceptable expenses are tuition, computers, transportation, tutoring, uniforms, books, and supplies.
In addition to college expenses, certain K-12 expenses are covered under a Coverdell ESA. This benefits parents who put their kids in private schools that have high tuition rates.
Coverdell accounts have more investment options than 529 plans 529 plans, 529 plans, potentially lower costs and tax-free treatment for K-12 expenses. They can be established anywhere in the United States at any bank or other IRS-approved entity. Investors have their choice of stocks, bonds, mutual funds and certificates of deposit. The contributor can make changes in how the funds are used, and avoid losing money because of bad investments. If you lose money, you are eligible to claim the loss on their tax return.
There are drawbacks to the Coverdell Plan. Unlike the 529 Plan, the Coverdell has a yearly deposit limit of $2,000 per child. Additional deposits are subject to an annual penalty fee. Also, the account must be created and deposits must end before the child turns 18. In order to be a qualified beneficiary, the child must be under 18 years old or a special needs beneficiary The account must be fully withdrawn by the time the beneficiary reaches 30 years old - at which point they must roll it over to a sibling under 18 or else it will be subject to tax and penalties. On the other hand, 529 plans are open to both children and adults.
Families must have a modified adjusted gross income (MAGI) of less than $110,000 ($220,000 if filing a joint return) in order to establish a Coverdell ESA. While there is no limit on the number of separate Coverdell ESAs that can be established for a designated beneficiary, the total contributions for the beneficiary in any year can't be more than $2,000, no matter how many accounts have been established.
Typically, as long as the distributions are not more than the beneficiary's adjust qualified education expenses for the year, the distributions are tax-free.
The Coverdell Account is a good option for families at a lower income level. Keep in mind that this is a per-child limit, not a family limit; meaning families with multiple children can deposit up to $2,000 per child. (Note: The low contribution limit means that a small annual maintenance fee charged by the financial institution holding your ESA could largely affect your overall investment return.)
Parents who want to send their kids to private school will also benefit from the tax-free incentives of Coverdell plans.
High-income families will not benefit much from this plan. The Coverdell Account has both deposit limit and income restrictions. Single parents making more than $110,000 and marries couples making more than $220,000 combined cannot use this plan. Single filing parents making over $95,000 and joint-filing parents making over $190,000 cannot deposit a full $2,000 per year.
Combining 529s and Coverdell accounts is an option to consider, but that option does not work for all families. For example, using the 529 prepaid plan option with the Coverdell allows contributors to purchase fixed tuition and to put away non-taxable money. For more information on the Coverdell Plan, visit: http://www.irs.gov/publications/p970/ch07.html
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