In first two blogs on tax-efficient college investment accounts, we discussed 529 Plans adn UGMA/UTMA accounts. Today, we’ll discuss one more option: Coverdells—so you can find the plan that’s right for you and your family.
Coverdell Education Savings Accounts, previously known as Education IRAs, were renamed in 2002 after the late Senator Paul Coverdell. What are they, and why are they worth considering?
Coverdells are qualified investment accounts that allow nondeductible contributions of up to $2,000 annually per beneficiary. Earnings in the account are not taxed, and withdrawals are tax-free as well as long as they are used for qualified education expenses.
Assets in a Coverdell must be used before the beneficiary's 30th birthday. Keep in mind that the designated beneficiary of a Coverdell account is free to take withdrawals at any time—but any amount in excess of qualified education expenses is taxable as income. An 10% additional federal tax might also apply.
Coverdell withdrawals may be used to pay for an elementary, secondary, or college education. However, unlike 529 plans, Coverdells impose income eligibility limits on contributors. Single filers with modified adjusted gross incomes of more than $110,000 and joint filers with incomes of more than $220,000 cannot contribute.
The deadline to contribute to a Coverdell is generally April 15, the same deadline that applies to IRAs—more commonly known as Tax Day. Before making a decision about a Coverdell, evaluate the investment options, fees, and services offered by competing financial institutions that provide the accounts.
Finally, when choosing a college investment vehicle, remember that it does not have to be a "one or the other" decision. It may make sense for you to contribute to more than one type of account simultaneously.
Speak with a financial and tax advisor about your particular needs.