Although 529 College Savings Plans seem to be a popular choice for today’s discerning parents and grandparents saving for future education costs, we believe the Coverdell Education Savings Account can be a better alternative for most people. Coverdell ESAs, in their current form are a relatively new type of education savings account. They were previously called Education IRAs and were very limited in their use and functionality. However, Coverdell accounts have evolved somewhat and now offer more benefits to families planning for the future costs of their child’s or grandchild’s education.
- $2,000 annual contribution limit per child
- Can be used for elementary, secondary, and post-secondary schools
- Tax free growth as long as they are utilized for “qualified” education expenses
- Only those with adjusted gross incomes of less than $220,000 (married filing jointly) can contribute to Coverdell accounts
- Child beneficiaries can be changed if the assets are not completely used by the original intended beneficiary
In contrast to 529 Plans, money accumulated in Coverdell ESAs could potentially be utilized to fund private elementary or secondary schools.
There are also some disadvantages to Coverdell ESAs including:
- Low contribution maximums will very rarely cover future education costs completely
- May negatively impact financial aid assistance since the accounts are considered an asset of the child
- There is a 10% penalty on “non-qualified” distributions
While the definition of “qualified education costs” is more expansive than the 529 Plan, Coverdell ESAs cannot be used for non-education expenses including summer camps, piano lessons, or automobiles.
We believe the best application of Coverdell Savings Accounts is as a supplement to other college savings alternatives (since the Coverdell contribution levels are so low). Coverdell ESAs can be especially useful if you think that your child is likely to attend a private elementary or secondary school.
To find out more information about saving for college, check out these articles.