According to the College Board, the average cost of tuition and fees for the 2013–2014 school year was $30,094 at private colleges, $8,893 for state residents at public colleges, and $22,203 for out-of-state residents attending public universities.
As the cost of college becomes more preventative, it may be helpful for parents of future college students to begin to utilize the various education savings accounts available to help save for the costs of rising tuition. Sure, it would be wonderful if your child received a scholarship or grant, but the truth is, that may not happen. Yes, student loans may be an option, but that comes with its own set of challenges by saddling the student with debt. While these savings plans may not cover the full costs of tuition and fees, it puts you (the taxpayer) in the driver seat by giving your control of the process and outcome.
Education:
There are several ways to save for the impending costs of college. Some of the investment or savings vehicles that are available to taxpayers are as follows:
1. Coverdell Education Savings Accounts
2. 529 Plans
3. Prepaid College Plans
In this lesson, we will focus on the Coverdell Education Savings Account (ESA), which is a savings account that is set up to pay the qualified education expenses of a designated beneficiary. As stated on the website saving forcollege.com, “this is perhaps one of the least-understood investment vehicles around.” Because of that, many taxpayers default to 529 plans, but the Coverdell ESA may actually be a better option for you and your beneficiary. The Coverdell ESA functions much like the Roth IRA account so while the contributions are not deductible, future distributions may be 100% deductible.
To help you understand how the Coverdell ESA works, let’s take a look at some of the advantages and disadvantages of the Coverdell ESAs.
Advantages of Coverdell ESAs
- Can be opened in the United States at any bank or other IRS-approved entity that offers Coverdells ESAs.
- Contributions can be made until the due date of the contributor’s tax return, without extensions (that is April 15th for most taxpayers).
- Distributions are tax-free as long as they are used for qualified education expenses.
- There is no tax on distributions if they are for enrollment or attendance at an eligible educational institution. The Hope and lifetime learning credits can be claimed in the same year the beneficiary takes a tax-free distribution from a Coverdell ESA, as long as the same expenses are not used for both benefits.
- The designated beneficiary can be changed.
- Assets can be rolled over from one Coverdell ESA to another.
- The beneficiary’s interest can be transferred to a spouse or former spouse because of divorce.
Disdadvantages of Coverdell ESAs
- Contributions are not tax deductible (made from aftertax dollars)
- Tax law prohibits ESA funding once the beneficiary reaches age 18. Total contributions limited to $2,000 per year, per beneficiary.
- Balance in the account generally must be distributed within 30 days after the beneficiary reaches age 30, unless the beneficiary is a special needs beneficiary or the beneficiary’s death.
- If the distribution exceeds qualified education expenses, a portion will be taxable to the beneficiary and will usually be subject to an additional 10% tax. Exceptions to the additional 10% tax include the death or disability of the beneficiary or if the beneficiary receives a qualified scholarship.
- Contribution limits may apply based on the contributor’s Modified Adjusted Gross Income.
- The beneficiary must pay a 6% excise tax each year on excess contributions that are in a Coverdell ESA at the end of the year.
- The relatively low contribution limit means that even a small annual maintenance fee charged by the financial institution holding your ESA could significantly affect your overall investment return.
Example – Contribution
When Maria Luna was born in 2012, three separate Coverdell ESAs were set up for her, one by her parents, one by her grandfather, and one by her aunt. In 2013, the total of all contributions to Maria’s three Coverdell ESAs cannot be more than $2,000. For example, if her grandfather contributed $2,000 to one of her Coverdell ESAs, no one else could contribute to any of her three accounts. Or, if her parents contributed $1,000 and her aunt $600, her grandfather or someone else could contribute no more than $400. These contributions could be put into any of Maria’s Coverdell ESA accounts.
In the next lesson, we will discuss 529 plans as a alternative investment option.
Resources:
Savingforcollege.com – Savingforcollege.com was established as a private company in 1999 with a mission to help individuals and professional advisors better understand how to meet the challenge of paying higher education costs.
Important terms from this lesson:
|
Term |
Definition |
| Coverdell Education Savings Accounts | A savings account set up in the United States solely for paying qualified education expenses for the designated beneficiary of the account |
| Qualified Education Expenses | Such as tuition and fees, required books, supplies and equipment and qualified expenses for room and board. |
| Eligible Education Institution | This includes any public, private or religious school that provides elementary or secondary education as determined under state law. Eligible institutions also include any college, university, vocational school or other postsecondary educational institution eligible to participate in a student aid program administered by the Department of Education. Virtually all accredited public, nonprofit, and proprietary (privately owned profit-making) postsecondary institutions are eligible. |
| Beneficiary | The individual (student) who is to be the recipient of future distributions. |
| Contributor | The owner or custodian of the account. |
Education and Action 