subject: Understanding The Coverdell Esa [print this page] The recent housing crisis of 2007 has put many families into a financial bind. Chief among their worries is education financing for their child's college tuition. Families who depended on home equity and general savings accounts encountered a crunch when values dropped in both real estate and the stock market. Higher education financial planning should be more intricate, and most certainly take advantage of the many government sanctioned plans whih offer a number of advantages.
The Coverdell Education Savings Plan is one such plan, initiated by a US Senator named Paul Coverdell and initially known as an education IRA. Its main purpose is to give families a financial vehicle to save money for education purposes only in a tax sheltered way. Their main difference from the 529 is that one may use any vehicle, such as stocks or mutual funds, rather than rely on a fund administered by a state-directed enterprise.
The tax benefits covers the growth and withdrawal phases. When money is put in, it is taxed as normal. When money grows, there are no capital gains taxes. When money is taken out, it is not subject to income taxes. However, there is a strong restriction: all money must be spent on qualified educational expenses. One ancilliary benefit was that the money does not have to be spent on college expenses; qualified primary and secondary school expenses also count. However recent legislation has removed this benefit. The qualified expenses are denoted in a list maintained by the IRS.
Students sometimes worry that their chances of obtaining financial aid is damaged by the presence of modest funds in a Coverdell or 529. However, as long as the primary account holder is not the student him or herself, then it is not counted when applying for federal aid.
While 529 plans do not have an age limit, Coverdells need to be distributed before the recipient in the family reaches 30. The recipient may be any family member. After the age of 30, money can still be distributed but is subject to a penalty and tax.
In recent years the Coverdell has fallen out of favor when compared against the more popular 529. The result is that fewer financial institutions support Coverdells, which must be invested in a finanicial instrument of the account holder's choosing unlike the 529. People who have existing Coverdells likely will be able to keep their accounts but prospective new account holders will have to look harder to find a custodian. Worse yet, withdrawals from a Coverdell means that one cannot take Hope or Lifetime learning credits.
The upper limit on contributions to a Coverdell used to be $2000 per year but even that has been struck a blow by Congress. New limits are $500 per year. These changes for the worse were intended to reduce the budget deficit in the federal government. Congress tried to take action on the 529s but opposition was too great, hence the development of disparity in benefits between the 529 and the Coverdell.
