Paying for a child’s college education is often a huge financial challenge parents. Even a public college can cost tens of thousands of dollars annually.
One option is simply to add a savings account to your personal banking accounts. However, what your child might really need is a tax-advantaged savings plan such as a Coverdell Educational Savings Account.
This way your kids can use their savings accounts for things they wish for and learn goal setting and financial planning. Read on to learn more about what is an educational savings account and how to open one.
What Is a Coverdell ESA?
The Internal Revenue Service describes a Coverdell ESA as a trust or custodial account. The only function of an ESA is to fund a child’s education. Coverdell ESAs are similar to IRAs. You can open the account at banks, credit unions, brokerage firms and mutual funds. Your child is the account’s designated beneficiary. He or she must be under age 18 or a special needs child for you to open the account and make contributions. Total contributions are limited to $2,000 per year. Contributions must be made before the tax filing due date for the calendar year. Coverdell ESA rules allow you to use a variety of investment types. For example, you can put the money into stocks, bonds, money market funds or mutual funds.
A Family Project
One reason your child needs an ESA is that anyone can add money to the account. Others can also open ESAs with your child as designated beneficiary. This means grandparents and other relatives can help you save for a child’s education. Friends and even employers can contribute as well. The only limitation is that the total contributions cannot exceed the $2,000 yearly limit. Investopedia.com suggests opening a single account in the parents’ name to make it easier to track contributions and earnings.
Benefits of a Coverdell ESA
Tax breaks are a major advantages of Coverdell ESAs. Money in an account grows tax free. Distributions are tax exempt if they are used for qualified education expenses. For a Coverdell ESA, qualified expenses include tuition, fees, books and required supplies. Services and equipment for special needs students qualify. Room and board are also qualified if the amount does not exceed the actual or estimated expenses as determined by your child’s school. Withdrawals can even be used for qualified K-12 costs. All funds must be used by the time a child turns 30. Anything left over is subject to taxes and a penalty
You may want to save more than $2,000 per year for your child’s education. If so, consider starting a 529 plan, which has tax advantages similar to those offered by Coverdell ESAs.