Coverdell Education Savings Accounts: Covering the Basics (page 2)
Coverdell ESAs are savings plans described in Section 530 of the Internal Revenue Code (IRC). They're accounts that Congress created to allow you to save now for future educational expenses, whether primary, secondary, or postsecondary, of a designated beneficiary.
You can invest money in Coverdell accounts in a variety of ways: stocks, bonds, money market accounts, certificates of deposit, and so on, although you may not invest in life insurance policies. And I really mean that you can invest; under the Coverdell rules (and unlike Section 529 rules), if you designate yourself the one responsible for all decisions on this particular account (also known as the responsible adult, who must be the parent or legal guardian of the minor child), you keep control of the money and make all the investment decisions for your child's account. Over the years, the investments will hopefully earn significant income through interest, dividends, and capital gains, until the time that the account is closed.
You pay no income tax on the income when it's earned, and as distributions are made from these accounts to your designated beneficiary for qualified educational expenses, the income portion of the distribution is not taxed, either to you or to your student.
A Coverdell ESA must be opened as such, in writing, and you need to designate a beneficiary when you create it; you aren't allowed to take an already existing account and decide that it's now the Coverdell account for your student. Money that you contribute into the account is held by a trustee or a custodian, which must be a bank, mutual fund company, or any other entity that's approved by the Internal Revenue Service (IRS).
Understanding Coverdell Changes
When these accounts were first introduced in 1997 as Education IRA's, they were limited to $500 a year aggregate contribution per student, and distributions could be used to cover only postsecondary expenses. If you were thinking of making a contribution into any plan, you probably would've chosen a Section 529 plan, which had fewer restrictions and allowed you to maintain some contact with your money. Basically, the old Education IRA was a nonstarter for most people because contribution limits were fairly pathetic, and much better ways to save money for college were available.
In the new world of Coverdell (same code section, different name), the aggregate contribution limit has been raised to $2,000 per year, the definition of "qualifying student" has been hugely expanded, and you may now contribute to both a Coverdell account and a Section 529 plan for the same beneficiary in the same year. With all these factors, plus an increase in the income phaseout limitations present under Coverdells but not 529 plans, these accounts can become useful savings tools for many families.
Knowing Who Owns The Account
No matter who makes contributions into a Coverdell ESA, the IRS considers the designated beneficiary to be the owner of the assets. If you structure the accounts for your children correctly, though, you can remain in control of the assets by naming yourself the responsible adult, or the person in control of the account, when you open the account.
If, when your children turn 18, your philosophy is to turn their finances over to them to help them establish their independence, or if you feel your child at that age is more savvy about money and investments than you'll ever be, you may put your child in control at that time, although you don't have to.
If your inclination is to give your child control of his Coverdell ESA account, think carefully before you do. As long as you remain the responsible adult, you make the decisions regarding distribution; your child may have other ideas about what constitutes appropriate use of the money in the account. Even though there are significant penalties for taking nonqualified distributions from a Coverdell ESA, 18-year-olds aren't known for making decisions based on sound financial reasoning; you have to understand that your child may decide to take the money you've saved for his college and run.
Identifying Qualifying Students
In a major departure from the Section 529 definition of "qualifying students," Coverdell qualifying students consist of almost anyone who's studying anything or who's likely to study anything at a later date. This means that, if your budding Picasso is taking up the fine art of finger painting at her local private kindergarten, you may choose to pay for the tuition there by using distributions from your Coverdell ESA. You can do the same at each step along the way, all the way up to and through college and graduate school. There are some caveats, though, that you need to remember.
Age Limitations At Time Of Contribution
In general, you have 18 years in which you, or anyone else, for that matter, can fund a Coverdell ESA for your child, from his date of birth until the day before his 18th birthday. After that, you're done. No matter how much or how little you've managed to put away for that student, you can't add any more to the account. Any increases from now until the termination of the account will have to come from the earnings off your good investments.
Age Limitations At Time Of Distributions
Coverdell ESAs must be completely distributed by the time your designated beneficiary hits his or her 30th birthday. If money is still left in the account on that date, it must be distributed within 30 days, and any earnings on it will be taxed to the beneficiary, plus whacked with a 10 percent penalty.
If you're fast approaching your beneficiary's 30th birthday and substantial money that you may not want to be giving as a birthday gift remains in the account, you can change the designated beneficiary on the account to a member of the current beneficiary's family, provided, however, that the new beneficiary is under age 30.
Saving For Disabled And Special-needs Students
While members of Congress have essentially stated that your children should have completed their educations by their 30th birthday, they do also recognize that some students will spend their lives in special schools. Accordingly, if you're the parent or grandparent of a special-needs student, there are no age limitations either on contributions or distributions on behalf of these students.
Regulations defining who exactly is a special-needs student haven't been released, and no one is sure where the line defining a disability will be drawn. For instance, total deafness may be included, but 50-percent hearing loss could fall outside the boundaries. If you feel that your student's disability or special need may not be severe enough to fit a narrow definition and if you're approaching the ordinary deadline for contributions, you may want to err on the side of caution and stop contributing at age 18 until clearer guidelines are available.
Recognizing Qualified Education Expenses
Qualified education expenses under Code Section 530 are those expenses that you're required to pay (or figure out some other way of meeting) if your student is to enroll at an eligible school. Just as in Section 529, though, many other expenses may be qualified, depending on the requirements of the school and of the particular program your student may be enrolled in.
First, you need to know what constitutes an "eligible school." For the purposes of IRC Section 530 and Coverdell ESAs, eligible schools include all public, private, or religious schools that provide either primary or secondary education as determined under their applicable state laws. All postsecondary educational institutions that are qualified under Section 529 also qualify as eligible schools under Section 530.
The addition of primary and secondary schools to the list of eligible institutions is quite a bonus, as it assigns tax-exempt status to earnings used to pay for primary and secondary school expenses (this is the one and only place in the entire Internal Revenue Code where this happens). This provision is a part of the Economic Growth and Tax Relief Reconciliation Act of 2001 that changed the Education IRA to Coverdell. This legislation expires on December 31, 2010. If it isn't extended or made permanent by that date, the law sunsets back to its pre-2002 conditions, in which only postsecondary educational institutions will be qualified.
Qualified Expenses For Elementary And Secondary Education
In addition to tuition and mandatory fees, other elementary and secondary education expenses may be eligible for payment using Coverdell distributions. Some expenses may seem obvious; others may surprise you:
- Books, supplies, and equipment related to enrollment: In these days of shrinking school budgets, parents need to supply their children with more and more of what used to be considered necessary school supplies. Amounts that you spend for pens and pencils, notebooks, erasers, and the like are included here. You may also use a distribution from your Coverdell to pay for textbooks and any other required reading material that's not supplied by the school district.
- Academic tutoring related to enrollment: The math or science tutor (or even a dance instructor if your child is a dancer attending a school for the performing arts) is covered here, but your child's extracurricular piano or dance lessons are not.
- Special-needs services for students with special needs or disabilities: If your student needs a one-on-one aide with him and the school doesn't cover the expense, this service qualifies, as does special equipment necessary to accommodate him. However, when assessing what qualifies here, remember that the regulations regarding special needs haven't been issued yet.
- Room and board, but only if a requirement of attending that particular school: Clearly, if you send your child to a boarding school 300 miles from your home, room and board would be required; if, however, you live in the next town, this expense may be questionable.
- Uniforms, when required by the school: The cost of voluntary school uniform programs doesn't constitute a qualified educational expense, nor does the annual cost of buying your child school clothes.
- Transportation, when required by the school: The expense of driving your student to and from school every day doesn't qualify, but the price you're charged for the mandatory school bus does. As more and more communities begin to charge families for the cost of transportation to and from school, this expense will become an item that more people may choose to pay from their Coverdell accounts.
- Supplementary items and services, including extended day programs: If your child attends an after-school program or an extended day program at his or her school, you may choose to pay these costs from your Coverdell account. The payment must be made to the school, however, so once again, those extracurricular piano lessons probably aren't covered here.
- Computers, printers, other peripherals, Internet access, software, and so on: To the extent that you can document that the use of this equipment and programming is to benefit your student's education, even if you may be the primary user of this equipment, you may pay for it by using a qualified Coverdell distribution. Items that aren't used for educational purposes, though, don't count as qualified expenses, so the video games, the joystick you buy for your computer, and any gaming, sports, or hobby software don't qualify.
- Kindergarten Sight Words List
- First Grade Sight Words List
- 10 Fun Activities for Children with Autism
- Signs Your Child Might Have Asperger's Syndrome
- Theories of Learning
- A Teacher's Guide to Differentiating Instruction
- Child Development Theories
- Social Cognitive Theory
- Curriculum Definition
- Why is Play Important? Social and Emotional Development, Physical Development, Creative Development