Coverdell Education IRAs and Non-College Expenses

Amid all the talk about the expiring Bush tax cuts and other impending changes to the country's fiscal picture, one change that could have a dramatic impact on Coverdell accounts--and the families who use them to pay elementary and secondary school costs--has gotten little attention.

Coverdell accounts, formerly called Education IRAs, allow for tax-free growth of savings set aside for educational expenses, much like a Roth IRA for education. Families may set aside up to $2,000 per year per child to help cover educational costs from kindergarten through college, and funds may be used for public or private schools. Contributions are not tax-deductible, but gains and qualifying distributions are tax-free. Funds may be added to the account until the student reaches age 18 and must be spent by the time he or she reaches age 30.

Advantages of Coverdell accounts include the fact that they can be used for a wide range of educational purposes and for students of various ages, but also the fact that funds can be invested in so many different ways. Unlike a 529 account, which is limited to investments chosen by the plan and which can only be used for college expenses, a Coverdell account may be invested in whichever stocks, bonds, funds, certificates of deposit, and so forth the account owner chooses.

The downside to a Coverdell is the limit on annual contributions, which, at $2,000, might not get you very far when it comes to tackling the high cost of college.

Education IRAs were first introduced in 1998. Originally, contributions were limited to $500 per child per year. In 2001, as part of the tax cuts signed into law under President George W. Bush, use of the Education IRA was greatly expanded and the measure was redubbed the Coverdell Education Savings Account after Paul Coverdell, a U.S. senator from Georgia who had supported this expansion and who had died the year before. Among the most significant changes were an increase in the annual maximum contribution--to $2,000 per child--and the expansion of covered educational expenses to include those for students in kindergarten through 12th grade.

Fast forward a decade and here we are, with the Bush tax cuts (which were extended under President Obama two years ago) about to expire and taking the expanded Coverdell provisions with them. That means that, unless Congress and the president act, beginning in 2013 Coverdell contributions will again be limited to $500 per year, and proceeds from Coverdell accounts will again be usable only for college-related expenses.

Source: Adam Zoll, Morningstar

The information contained in this article does not constitute a recommendation, solicitation, or offer by D2 Capital Management, LLC or its affiliates to buy or sell any securities, futures, options or other financial instruments or provide any investment advice or service. D2, its clients, and its employees may or may not own any of the securities (or their derivatives) mentioned in this article.

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