I did a Primer on 529 plans and a Pros and Cons of 529s article as well, and today we’re going to talk about a different way to save for your kids college: Coverdell Educational Savings Account (which I will call ESA for the rest of the article). Basic things to know from the IRS:
- You can put up $2000/year but you are still limited to $2000 even if you have several accounts
- Beneficiary of ESA must be under 18 years old throughout the time you’re making contributions
- ESA contributions are NOT deductible, which means you pay taxes on the amount you put in each year normally on your return as you would any other money you make
- Growth on ESA contributions are tax free as long as you use the money for qualified education expenses at an eligible educational institution.
- You can use your ESA savings on elementary, middle, high school or post-secondary education. Yes, you heard me: you can use your money on private school!
- If your child (Beneficiary) doesn’t go to college, the funds in the ESA are distributed to him/her and NOT back to you. Deal with it!
- ESA is treated like a 529 plan for financial aid. It is considered an asset of the parent/guardian
- ESA funds MUST be distributed to a beneficiary or rolled over to another beneficiary by the beneficiary’s 30th birthday. Could be a problem for late bloomers.
- You can use the money for PRIVATE SCHOOL or elementary, middle and high school. You cannot do that with a529 plan.
- You get to choose how to manage the money in the account; stocks, bonds, cash or a combo. In a 529 plan you have to choose a manager who makes the decisions and you pay the manager.
- Yes, your money grows tax free if you follow the guidelines outlined above.
Not so positives:
- You can only contribute $2000/year
- You cannot make ANY contributions if their annual adjusted gross income is higher than $110,000 (single) or $220,000 (married)
ESAs are a nice ‘supplement’ to your college savings or a fund from grandparents, but are not going to get you there. At $2000/year, when you fund an ESA at the birth of your child, assuming 4% annual interest, you will have just over $55,000 when your child turns 18. One year of an Ivy League school and maybe a couple of years at a state school depending on the state.
For private school, you’re talking about up to $30,000/year for elite private school in big cities and several thousand for parochial or private schools elsewhere. ESA savings at $2000 per year simply won’t help much on private school because you will use it faster than you can save and grow it in an ESA.