Educational IRAs?
The Educational IRA is another name for the Coverdell Education Savings Account. Still another name is the Coverdell IRA. This type of tax advantaged savings plan was created in 1997, the same year that the Roth IRA came on the scene. The Coverdell plan is very similar to how a Roth IRA works, but with a few twists.
The Coverdell is also not the only tax advantaged plan to save for higher education costs. A very popular type of plan is the 529 plan, which takes its name from the section of the tax code dealing with these plans. In fact, the 529 plan is many times more popular than the Coverdell due to reduced age requirements and lack of contribution limits.
In discussing the Coverdell IRA, you should compare it to the 529 plan to see which plan is best for your needs.
Coverdell IRA or a 529 plan
Both the Coverdell ESA and the 529 plan allow you to set up accounts for a beneficiary to pay for the cost of higher education. Unlike a custodial account where your child can spend the money anyway he wishes at age 18, the Coverdell and 529 plans can only be used for educational purposes.
Both these investment plans are set up like Roth IRA’s. You make after-tax contributions to the plans and all earnings or capital gains accumulate tax deferred. Then, if you make withdrawals to pay for higher education, the withdrawals are totally tax free.
Costs include tuition, books, fees, room, board, laptop, and even cell phones.
Differences between a Coverdell ESA and a 529 Plan
There are some important differences between the ESA and the 529 plan
The Coverdell ESA:
- In the ESA, the total contribution for any one beneficiary is limited to $2,000 per year.
- The $2,000 contribution limit will be reduced if your adjusted gross income is between $95,000 -$110,000 for single persons, or $190,000 to $220,000 for married persons. No contribution is allowed if your AGI is over the higher of these earnings limits.
- There are age limits in the ESA. The beneficiary must be under age 18 to receive contributions, and must make all withdrawals by age 30
- Funds may be used for private schooling between grades 1-12, as well as higher education
- Funds may be invested in just about any type of investment desired
The 529:
- There are unlimited contributions to a 529 plan
- There are no age limitations
- Funds may only be used for higher education, not high school or grade school
- The investments under the 529 plan are handled by a number of investment managers chosen by the state in which you reside. While this allows for professional management of assets, the investment objectives of these funds may not match your own investment objectives, so be sure to speak with a professional.
