When it comes to funding your child's education, putting money away a little at a time is a practical way to approach it. Why? Because the reality is, the cost of both private primary education and college tuition continues to rise. So rather than subject your child to taking out student loans that might take advantage of a young person, you might want to consider funding his or her education through a Coverdell education savings account.
Many parents leverage interest to grow their child’s education fund money even more. Coverdell education savings accounts allow you to do just that. This particular education savings account can be used to pay for K-12 education, but must be opened before the child reaches the age of 18. An added benefit to this type of account is that the beneficiary does not have to be your own child; he or she can be your grandchild, niece, nephew, or godchild.
The Rules of Coverdell Education Withdrawals
Like most education savings accounts, there are rules regarding withdrawals. This is to ensure the funds are used appropriately and for the purpose of education.
Because of this, there are limitations to withdrawing money from a Coverdell education savings account. You cannot withdraw money for any reason other than to pay for an education-related expense.
For instance, qualified expenses for elementary school include room and board if your child attends a boarding school, transportation, tutoring, after-school programs, and any expense related to special education resources. The beneficiary of a Coverdell education savings account can take out money tax-free.
There are no limits to the amount of money you can withdraw from a Coverdell education savings account, but there are limits to the amount of money you can put in, which is up to $2,000 per year per child. If you try to contribute more you will receive a penalty. The downside to the low contribution amount is that even a small annual maintenance fee charged by the financial institution holding the account could have a significant impact on your overall return on investment in the long run.
Something to keep in mind is that any money going towards college education from a Coverdell account will be taken into consideration if your child applies for FAFSA. He or she may become ineligible for financial aid in this case.
If you make any contributions to a Coverdell account after your child turns 18, you will be subjected to a 6% tax. And you must withdraw all funds and apply them to education before your child turns 30, otherwise, the remaining funds will be paid out within 30 days and will incur both income tax and a 10% penalty tax.
Where Can I Open a Coverdell Education Savings Account?
Opening a Coverdell education savings account is easy! You can open one at ALEC, a mutual fund house, or brokerage firm. All of these financial institutions will have their own fees associated with opening an account.
What is the Savings Account Income Limit?
There are limitations to opening and owning a Coverdell education savings account. Your annual gross income cannot exceed $110,000 as a single filer or $220,000 if filing jointly.
If your income is too high to open an account for your child, consider asking a relative, like a grandparent, to open one in their name and contribute towards the account via a gift.
Coverdell Education Savings Account vs. 529
By now you have a sense of what Coverdell education savings accounts are like. But how do they compare to a 529 savings account? Coverdell education savings account funds can be used toward qualified education expenses for all educational levels: meaning kindergarten through college. Meanwhile, 529 plans have a limited payout of $10,000 for only private school tuition if using it prior to college.
Coverdell education savings accounts are less flexible than 529 plans. For instance, with Coverdell, you may only contribute up to $2,000 per year whereas there is no maximum level of contribution for 529 plans. 529 plans are designed for college savings and offer tax-free growth and withdrawals when it comes time to use the money towards education. Coverdell accounts can be used from kindergarten through college.
Setting Up Your Child for Success
Take control of paying for your child’s education by looking into a Coverdell education savings account. Adding to this account a little each month and then letting the account grow through interest will help ease the burden of education-related expenses.
For more information about securing your child's future through education, click below to learn about private student loans.
* This content was prepared for informational purposes only and is not intended to provide tax, legal, or accounting advice. Consult your own tax, legal, and accounting advisors before engaging in any transaction.