Coverdell Accounts

LIKE 529 COLLEGE savings plans, a Coverdell education savings account can give you tax-free growth if the money is used for qualified education expenses. A Coverdell is also typically treated as a parental asset for financial aid purposes—another attractive feature—and, like a 529, it can be used to pay for education expenses from kindergarten through college.

But there the similarities end. While 529 college savings plans restrict you to the plan’s menu of investment options, you have a much wider choice with a Coverdell, which means you could potentially slash your investment costs by, say, favoring index funds with rock-bottom annual costs.

But that advantage is offset by a few notable disadvantages. You can invest just $2,000 a year in a Coverdell. The amount you can contribute phases out if your modified adjusted gross income is between $190,000 and $220,000 and you’re married filing jointly, or between $95,000 and $110,000 and you’re filing as single or head of household. Above these income thresholds, contributions aren’t allowed. These income eligibility thresholds do not rise each year with inflation.

You could sidestep the limits by having a family member with less income make the annual contribution. Indeed, you need to be aware of what others are doing, because the $2,000 annual limit is a total amount per child. Thanks to these various drawbacks, the Coverdell hasn’t proven that popular, and some financial firms have stopped offering them, instead focusing their efforts on 529s.

Once the beneficiary of a Coverdell turns age 18, you can’t make further contributions. The account needs to be emptied within 30 days of the beneficiary turning age 30. But if, as that deadline approaches, there happens to be money left in the account, you can keep the tax-free growth going by switching the account’s beneficiary to another family member who is under age 30.

Next: Custodial Accounts

Previous: Prepaid Plans

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