Monday, March 27, 2023

With the new school year approaching, and our concerns regarding financing our children’s education, I will devote the next two articles to educational savings accounts (ESAs)—529 plans and the Coverdell Education Savings Account. Today’s discussion will focus on the latter. This is a tax-advantaged savings account that is established to pay for qualified education expenses on behalf of a designated beneficiary. Most of us are faced with substantial tuition expenses for our children’s kindergarten, elementary and high school education as well as college, postgraduate and professional schools.

Non-tax-deductible contributions must be made to a beneficiary who is less than 18 years old. Earnings from these investments are tax-deferred and are tax-free if used for qualified education expenses. Unlike 529 plans, which can only be used for higher education, Coverdell funds can be utilized from kindergarten through college for qualified educational expenses, including tuition, room and board or other related costs, as well as for a computer that is used by the child. Contributions can be made until age 18 and must be utilized prior to age 30. These age limitations of 18 and 30 are waived if the beneficiary has special needs. In many cases, the beneficiary can be changed. However, the new beneficiary must be a member of the previous beneficiary’s family—including children, grandchildren, siblings, spouses, nieces, nephews, aunts, uncles, cousins and in-laws.

A maximum of $2000 annually can be placed in the Coverdell account. The account can have multiple contributors, but only one beneficiary. A child can have both Coverdell and 529 accounts. Coverdell accounts can be established at most banks, credit unions, mutual fund companies or brokerage firms. Contributors not constrained by income limitations can deposit directly into a Coverdell account. Investment of the assets is very flexible and can be consistent with the parents’ investment goals and risk tolerance. A drawback of a Coverdell account is that if the beneficiary applies for financial aid, the contents of the Coverdell account are viewed as the beneficiary’s assets.

Contributions can be made for any particular year until April 15 of the following year—the income tax return due date. Monies not utilized by age 30 and not transferred to another beneficiary are subject to ordinary income tax plus a 10 percent penalty on the earnings. The same restrictions also apply to withdrawals made for nonqualified purposes.

The value and use of Coverdell accounts often has been limited because of income limits on contributors—the modified adjusted gross income (MAGI) must be less than $190,000 for a couple or $95,000 for an individual. However, this limitation, when relevant, may be circumvented for most potential beneficiaries. As few children have such substantial incomes, using a child’s Social Security number, an adult can open an account on behalf of a minor and act as the account custodian. These accounts are classified as Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA) accounts. Coverdell contributions can then be made as gifts to the child. The child can then be the contributor and avoid the potential income limitations that could apply to the child’s parents or other contributors. This thus becomes an attractive, meaningful and practical means for parents, grandparents, relatives and friends to gift the child on appropriate occasions and these funds can be invested and utilized for the child’s education. In summary, the often-overlooked Coverdell accounts can be a meaningful way to save for your child’s education.

Questions and comments on the topics discussed in this paper should be submitted to [email protected] The next article will cover 529 education savings plans.

By Norman Sohn

 Norman Sohn received his MD degree from New York University and his MBA from Fairleigh Dickinson University. He completed a 15-month course in financial planning. Since his retirement from his position at Lenox Hill Hospital in 2010, he has been working at Beacon Wealth Management, LLC — a financial planning and wealth management firm in Hackensack. He completed his Series 65 examination, which qualifies him as an investment professional and allows him to operate as an Investment Adviser Representative. He also passed the Chartered Retirement Planning Counselor examination, which provided him with the designation CRPC®. He lived in Englewood for over 40 years and for the past four years has been married to Lois Blumenfeld and living in Teaneck. Together, they have seven children, 26 grandchildren and a host of great grandchildren. He is an active member of Congregation Bnai Yeshurun. He can be reached at [email protected]


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