A Coverdell Education Savings Account (ESA) allows you to put aside money for your child’s education. This tax-advantaged account grows over time and withdrawals used to pay for qualified education expenses can be distributed at any time tax free. The most important reason to establish a Coverdell is to help defray the extremely high cost of schooling. According to statistics, the average cost of a public college is almost $22,000, while a private one is $50,000 annually. This doesn’t even include the cost to get your child through high school!
Why Establish a Coverdell?
The main reason to establish a Coverdell ESA is the benefit it offer to the saver. Just like saving for retirement with a 401(k) or IRA, a Coverdell gives you another way to eliminate taxes. Unlike a retirement plan, a Coverdell does not come with an upfront tax break. You cannot deduct your contributions from your gross income on the year like you can with a traditional retirement plan. However, so long as the funds in your Coverdell are used to pay for qualified education expenses, you will not pay any tax. Imagine putting aside $2,000 (the annual limit) every year until your child reaches age 18. Put that in a savings account and you might earn one percent. Put that in stocks and mutual funds and you can earn about seven percent (based on historical averages). Self-direct your HSA and invest in alternatives, such as real estate, and you might see even higher returns.
No matter your investment strategy, that $2,000 annual contribution will amount to a lot more in a Coverdell than it would in your bank account. If you contribute $20,000 over the years to your Coverdell and it doubles in value, you have $20,000 in tax-free funds to help pay for schooling. If you have more than one child, you can contribute $2,000 for each. On top of that, relatives, friends and even corporations can help fund the plan. When your son or daughter starts college and you need a $1,000 to pay for books and supplies, you can withdraw the funds from your Coverdell ESA tax free!
What About a 529 Plan?
Many argue that a 529 Plan is a better option that the Coverdell ESA. There are no contribution limits, other than the total expected cost of schooling, anyone can fund the plan since there are no income restrictions, and they offer similar tax advantages to the ESA. However, there are a few items that make the Coverdell ESA a better option.
First, while both plans cover qualified higher education expenses, there is a difference concerning K-12 expenses. A 529 can only be used for tuition for elementary and secondary expenses. However, only a Coverdell can be used for more than just tuition, such as books and supplies, tutoring services and room & board.
The biggest differences and the reason you should establish a Coverdell ESA over (or in addition to) a 529 plan is the investment opportunities. With a 529 plan, there is a set of investments based on the age of the beneficiary. These investments can adapt as you get closer to college, or remain the same. However, with a Coverdell, you have the opportunity to self-direct the plan and invest in almost anything you want. This gives you greater control and the ability to reap greater rewards.
Of course, the Coverdell is not without its disadvantages. The annual limit is still quite low at $2,000. The plan can only be funded until the beneficiary reaches age 18. Lastly, the funds from the plan must be withdrawn full once he or she reaches age 30. Although, it can be rolled over to certain relatives of the original owner.
Establishing a Coverdell ESA is Easy
A Coverdell can be opened at most financial institutions, both in person or online. Essentially, if a bank, trust company or other business offers an IRA, they probably offer an ESA option. Of course, you are limited to what you invest in when choosing one of these providers. At IRA Financial, we put your needs first, which is why we offer a Self-Directed Coverdell ESA. Just like our other self-directed products, you have the freedom to choose your investments based on your own personal goals and risk tolerance.
If you want a hands-off, cookie cutter experience, you can simply go to your local bank and open an account. This is totally acceptable! Many people don’t have the time or know-how to invest their savings. Traditional institutions tailor investments that can work for you. However, if you want to do more with your money and are willing to put in the work, self-directing is the way to go. The more investments available to you, the better you can diversify your holdings and hedge against a volatile stock market.
For any questions about how to establish a Coverdell ESA, feel free to give us a call at 800.472.1043. Your children’s future is riding on it! Let us help you save the right way for the extraordinary cost of education!
