Coverdell Savings Account: Definition, Pros and Cons
A Coverdell savings account, or a Coverdell Education Savings Account (ESA), is an investment account that is tax-free when used for qualified higher-education expenses.
Assets in Coverdell accounts can be transferred to other family members if the beneficiary doesn't need the money (whether because of scholarships or other circumstances) and many find the main benefit is that these funds can also be used for K-12 school-related expenses. The biggest drawback is that you cannot contribute more than $2,000 per year, even across multiple accounts.
Coverdell ESA Basics
How to open: The Coverdell ESA is opened with a brokerage or mutual fund company and its assets are owned by either the parents or the student.
Limits: Contributions are phased out at incomes between $95,000 and $110,000 for single tax filers, $190,000 to $220,000 for married filers (though there are some ways around these limits). Contributions can be made until the student turns 18 and must be withdrawn by age 30. The deadline to open a Coverdell ESA: April 15.
Related: What the IRS says about Coverdell accounts
Investment choices: Whatever is offered by the company with which you've opened the account.
Impact on financial aid: Depends on the account owner. Assets owned by a student have a greater negative impact on aid eligibility than assets owned by the parents, though this impact is lessened if the student is still a dependent of the parents.
Related: the savings calculator at Savingforcollege.com. It estimates the total cost of college based on your child's age and tells you how much you need to save each month to reach that goal. The calculator has plenty of flexibility that allows users to fiddle with the assumptions, and it can even help look up the costs of specific colleges.
Why choose the Coverdell: If you want maximum control over your investments in terms of what you can buy and how often you transact, this is the education savings account for you. Also, unlike with 529 plans, Coverdell assets can be used for elementary- and high-school expenses. However, given the low contribution limits, saving only in a Coverdell will likely not be enough.
The good news is you don't have to choose just one of these accounts. You can contribute to each, if you have the resources and it makes sense for your situation. For example, you might participate in a prepaid plan to manage the future costs of tuition, then max out the Coverdell (because you enjoy picking individual stocks, an investment choice not available in 529 plans) to help cover room and board, and contribute to a 529 savings plan for additional savings. Of course, such a strategy would require a lot of cash; for those seeking a place to contribute a few hundred dollars a month, the 529 savings plan is the most popular choice.
Finally, attempt to persuade your kids to choose a degree that has greater chances of paying off (unlike these degrees). Yes, choosing a career you enjoy is important, nearly crucial. But college is an investment, and like every investment, there should be a cost-benefit analysis. Going into a huge amount of debt for a low-paying career makes paying for a car, paying for a home, raising a family, and taking vacations — also important factors in life satisfaction — much more difficult.
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