Continuing to look at higher education savings options, this month we will look at Coverdell ESAs.

Originally these were titled Education IRAs. When updated in 2002 they became more attractive as an education savings vehicle.

Advantages:
•    Can be utilized for primary and secondary education expenses.
•    Works similar to a Roth IRA in that contributions are made on a post tax basis and all withdrawals are tax free.
•    A Coverdell ESA can be rolled over into a 529 plan if desired.

Disadvantages:
•    A maximum of $2,000 annual contribution per beneficiary from any source.
•    No contributions can be made once the child is 18.
•    Coordinating withdrawals, especially with the Hope and Lifetime Learning credits can be tricky.
•    The funds will be distributed to the beneficiary at age 30, even if not used for education.

Tax considerations:
•    If over $2,000 is contributed from any source to a beneficiary, a penalty will be applied.
•    All the funds must be withdrawn by the time the beneficiary reaches 30 or penalties are applied.
•    Care must be used to avoid withdrawing more then the Qualified Expenses in any year or a 10% penalty tax will be due. Qualified expenses are tuition, books, some fees and a limited amount of room and board expenses.

Estate planning considerations:
•    Care should be used if changing beneficiaries to avoid problems with gifts over the annual limit ($12,000) or generation skipping taxes.

Considerations:
•    The account is typically an asset of the custodian, usually the parent. Care should be used when setting up the plan to minimize the effect on the FAFSA.
•    The responsible person can change the beneficiary designation. However, a grandparent cannot name themselves as the custodian. Typically a parent is named.
•    The update act sunsets on 2010. At this point the contribution limit will return to $500 and the funds cannot be used for primary or secondary education.

Resources:
www.savingforcollege.com
IRS Publication 970 - Tax Benefits for Education