With one in the oven and one quickly approaching kindergarten age I think it is definitely time to get serious about saving for our children’s education. Our current method of saving is to automatically transfer $20 a paycheck into an ING Direct account for my oldest. Obviously this is not a cure all college fund but it is a start and can hopefully go towards some major purchase, say a car, that he may need when he is older. We plan to implement a similar methodology for our second shortly after he is born. That makes it ~$8640 contributed over 18 years. If you take into account compound interest at 1.40%, ING Direct’s current rate, than you get a total of ~$9,820. That isn’t to shabby but it certainly isn’t going to pay for college 18 years from now, hell it probably won’t even cover the application fee. But what other options are there? It turns out there are a couple of viable options for saving for college. I will briefly discuss one today.
Coverdell Education Savings Accounts (ESA)
The Educational IRA was replaced in 2002 by the more robust and attractive Coverdell Educational Savings account. These accounts operate much like your ROTH IRA for retirements, but are geared towards education. You can make yearly nondeductible contributions to the account where they grow tax free. If you meet certain requirements at withdrawal time you also get to make your withdrawals tax free.
If your adjusted gross income is below $190,000, for joint filers, or $90,000, for single filers, you can contribute the yearly maximum of $2,000 for the qualified beneficiary. If you are above the income limits the contribution amount is gradually phased out but you can get around the limitation by simply gifting the money to the child and then having them make the contribution.
What Can it be Used For?
One of the cool things about educational savings accounts is the act you can use them to pay for qualified primary and secondary education (K-12) expenses such as
- room and board,
- computer technology, and
- internet access
In addition to K-12 education the accounts can be utilized to pay for qualified higher education expenses such as books, tuition, and to some extent room and board. You have to take into consideration other forms of help like employer programs and scholarships and subtract those amounts from your qualified expenses.
Who is in Control of the Account?
Unlike a 529 plan you are just the trustee on an ESA and the account can only be used to benefit the child. As the manager of the account you have the option to change the beneficiary but you cannot refund the money to yourself. If you are opening account for a grandchild or nephew you probably won’t be able to name yourself as the manager either, you would have to name the parent or guardian of the beneficiary. At that point you have 0 control over the account at all.
Other Things to Keep in Mind
- Contributions are seen as a gift to the child, along with your 529 contributions you need to watch out for hitting the maximum allowed for that tax year.
- If the account isn’t emptied out by the time the beneficiary reaches 30 you will get hit with taxes and penalties.
- If your child doesn’t attend college you can change the beneficiary to any other qualifying family members under 30, including brothers, sisters, children, nieces, nephews, uncles, aunts, and more.
- In 2010 some of the ESA benefits like K-12 expenses and the contribution limit of $2,000 are set to expire. If congress chooses to do nothing you will be stuck with a $500 per year max contribution and no more K-12 expenses can be claimed through your ESA.
Where Can I Open One
Just about anywhere that deals in IRA’s will be able to also get you a Coverdell ESA. If you have a broker you can talk to them about setting you up an account or you could check out other places like Vanguard or check with your local bank. I know BB&T offers ESA’s and IRA’s, it pays to ask around and do research. You only get $2,000 a year to invest so you are going to want to put it somewhere with good options.