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One such program does exist. The Coverdell Education Savings Account, formerly known as the Education IRA, allows for earnings from contributions to be exempt from federal taxation. Although the $2,000 maximum annual contribution per child is not tax-deductible, earnings from the investments are-as long as they are used for "qualified education expenses."
Qualified education expenses include expenses for tuition, fees, books, supplies, equipment required for enrollment or attendance and room and board (when provided by the school).
But the uses go beyond what you might imagine. For example, here are some of the supplies and services that have met the "qualified education expense" definition:
- Computers, computer software and internet access
- School uniforms
- Transportation
- After-school/extended day programs
- Tutoring and special needs services
You can see by these examples that a Coverdell can benefit not only families with children in private or parochial schools, but those with kids in public school as well. Any parent who has purchased a laptop computer for their children can attest to that.
You can open a Coverdell account at any bank or brokerage, as long as your child is under age 18. Unless he or she has special needs, the money you put in the account must be used before he turns 30. Extra or unused money in a Coverdell account can be rolled over to another beneficiary, but it's complicated, so talk to your financial advisor before you do it. Of course, Coverdell funds can also be used for qualified higher education expenses, too, so don't worry if you have a balance after high school graduation-colleges around the country are just as eager to take those dollars!
If you're looking into opening a Coverdell account, be sure to inquire about commission costs and other annual account fees. High annual costs for keeping an account could negate the tax benefits you can receive by opening the account in the first place.
Also, the federal tax benefits start to phase out for married couples with gross incomes over $190,000 and disappear completely at $220,000. Remember, it's $2,000 per year per student, not per contributor.
To see the potential benefits, assume we're working with a family with two children attending a private school. By putting $2,000 per child per year into Coverdell accounts, a family could put away $40,000 over ten years. With modest investment success of ten percent per year, the family would have nearly $64,000, none of which would be subject to state or federal tax when it's withdrawn. With a 12% return, the accounts would be worth more than $70,000.
The Coverdell program offers an additional benefit over the 529 plans: investment flexibility. The 529 plans managed by the state do offer several investment philosophies, but you are required to choose from a limited selection of investment options. Coverdell accounts can be invested in stocks, bonds, mutual funds, options and more. While many individual investors may not choose to actively manage the account, that option is available.
Think of it another way: if you are financially able to make a contribution, and you will be paying the education expenses anyway, and you meet the qualifications, why wouldn't you open a Coverdell account? Uncle Sam doesn't offer as many freebies as he used to: take advantage when you can. |
