If you have children, or if you’ve ever been a child, you know that saving for college is akin to teaching children to brush their teeth—it’s an investment in their long-term well-being. Given the rising costs of college and the debt load many graduates (and their parents) may carry, it may be important to start saving before they start teething.
Sure, regular deposits into a savings account can be a fine way to get going, but many investment professionals suggest looking into investment accounts such as Coverdell Education Savings Accounts as a way to help augment those savings.
Coverdells: Kindergarten to College
A Coverdell ESA is a trust or custodial investment vehicle that allows you to contribute money for a designated beneficiary tax free, and withdraw it tax free when the funds are used to pay for qualified education expenses. Contributions can be invested in a variety of assets like stocks, bonds, and mutual funds. Contributions are not tax deductible.
Education expenses, in the case of Coverdells, cover a relatively broad range—the funds can be used for any eligible private, public, or religious kindergarten, elementary, or high school, as well as higher education, according to the IRS. That sets them apart from some other investment plans that do not allow funds to be used for anything but post-secondary education.
Qualifying expenses include tuition and fees, of course, plus books, supplies, and equipment such as computers and tablets, software, Internet connections, and even academic tutoring. They can also be used to cover the costs of room and board, uniforms, transportation, and supplementary items like extended after-school programs.
Non-qualifying expenses include computer software for sports, games, and hobbies, “unless the software is predominantly educational in nature.”
As of March 2017, the annual contribution to each designated beneficiary (namely, “student”) may not exceed $2,000. Each student can have more than one Coverdell ESA, but the total amount deposited in all of them must not exceed $2,000 in each calendar year. But a bill currently making its way through Congress could increase the annual limit to $10,000. Also up for possible adjustment is the age limit for annual contributions. Under current rules, contributions are allowed to be made for individuals under the age of 18. The proposed bill would raise the age limit to 22.
An Alternative or an Add-On to Other Plans
Coverdell ESAs can be considered an alternative to 529 college and savings plans or an add-on to them. Yes; you can invest for the kids’ education in both accounts simultaneously.
Like most investment vehicles, there are pros and cons, and the pros of Coverdells—tax-free withdrawals, breadth of qualified expenses, and flexible investment options—must be weighed against the drawbacks, such as the age limit of 18 and the annual contribution limit of $2,000. However, beneficiaries can withdraw the money for education-related expenses until they are 30 years old without incurring federal taxes and a 10% penalty.
There’s also an income limit for those who fund a Coverdell account. Contribution eligibility phases out for incomes between $190,000 and $220,000 for couples, and between $95,000 and $110,000 for single filers.
TD Ameritrade does not provide tax advice. Clients should consult with a tax advisor with regard to their specific tax circumstances.
All investing involves risks, including loss of principal.
Educational Resources, All in One Place
The cost of college is high, but an education account can help you put aside money to help pay for your child’s college expenses down the road.