Since school is top of mind for many this time of year, I’m doing a short series of posts on college savings plans and their tax benefits. In my first post on this topic, I provided an overview of college savings plans with a focus on the 529 plan. If you missed it, you can read it here. While the 529 is one of the more popular plans, there are other options and it is wise to do a little research to find the one that is best suited to your family and financial needs.
An alternative to the 529 plan is the Coverdell Education Savings Account (ESA). Like any plan there are pros and cons with an ESA. A distinguishing feature of the ESA is that the benefit applies to qualified elementary and secondary education as well as higher education. Some may consider this plan more limiting as there are caps on annual contribution amounts, age restrictions on the beneficiary and contribution limits based on the contributor’s income.
Quick run-down of the key features of college savings
- Contributions limited to $2000 per year.
- A beneficiary must be under 18 years old or a special needs beneficiary.
- Contributions grow tax-free until distributed.
- A beneficiary will not owe tax on the distributions if the distributions are less than the qualified education expenses at an eligible institution.
- The benefit applies to higher education and qualified elementary and secondary education expenses.
- 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.
- There are contribution limits for taxpayers based on the contributor’s Modified Adjusted Gross Income.
Since ESA’s tend to be a long term type of savings, plan it is important to keep good records and review them at least annually. You don’t want to lose track once your child has gone off to school. If there is a balance in the Coverdell ESA when the beneficiary reaches age 30, it must be distributed within 30 days or rolled over to another qualified beneficiary. If not distributed or rolled over, the portion representing earnings on the account will be taxable and subject to the additional 10% tax mentioned above.
For more information, the IRS recently published a bulletin: IRS Summertime Tax Tip 2013-19: Back-to-School Tax Tips for Students and Parents
These plans are a great way to invest in the future of your kids and realize tax benefits here and now. If you have young children, the cost of getting them through school may seem daunting. With statistics putting a four-year degree at $50,000 and up and average student debt at $40k, starting early and utilizing the tools available can help ease the financial burden on both you and your child.