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Coverdells? Not nearly as much fun as they used to be

Posted by Cheryl Costa  April 21, 2010 09:55 AM

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One of the many ways parents can save for their children's college education is to use Coverdell Education Savings Accounts.  These accounts, which were previously called education IRAs, were never as exciting as 529 accounts because the amount you were allowed to contribute was very low - $2,000 per year per child - and there were income limits as well.  Income phase-outs on contributions started at $95,000 for individuals and $190,000 for joint filers.  In comparison, the contribution limits for 529 plans are upwards of $300,000 and there are no income limits.

However, one of the neat features about Coverdells was that the money in the account could be used for pre-college education expenses.  So, if your son or daughter were attending a private elementary or high school, you could take tax free withdrawals from the Coverdell to cover those expenses.  With 529 accounts, withdrawals have to be for qualified college expenses.

So, Coverdells did have their place, and some people really liked them, but now the rules for Coverdells are changing.  Starting next year, withdrawals from Coverdells that are used to pay for expenses for private kindergarten through 12th grade will no longer be tax free and it appears that the contribution limit will fall from $2,000 to $500.  (It is possible that Congress will step in at the last minute and prevent these changes from happening, but that seems unlikely.) 

If you have a Coverdell now and still contribute to it, you should give some thought to using the money in the account for expenses that you will incur this year.  In addition to private school tuition, you can use Coverdell money to pay for books, computers, tutoring services, room and board expenses, school uniforms and transportation to and from school.  Given the relatively low contribution limits, it is unlikely that very many people have large Coverdell balances, so cleaning out the account by the end of this year might be pretty easy.  But what if you don't have any expenses to claim this year?  There is no problem there either as Coverdell money can just as easily be used for college expenses.  Remember, the only "catch" with using Coverdell money for college age students is that any money remaining in the account when the beneficiary turns 30 will generally be distributed (and will be taxable) unless the person who originally opened the account changes the beneficiary.

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