The tax savings from the Coverdell Education Savings Account, or Coverdell ESA, is about to expire. Unlike the 529 savings plan, the Coverdell could be used to pay for tuition or other expenses for a student in kindergarten through 12th grade, as well as to cover college. That’s about to change…
Beginning in 2011:
- Any earnings you withdraw will be taxable as ordinary income and subject to a 10 percent penalty unless used for college expenses.
- The maximum allowable yearly contribution to a Coverdell account will be lowered to $500 from $2,000.
What to do:
- Spend: If you have a K-12 child, consider paying your education expenses using a Coverdell tax-free distribution before December 31, 2010. Coverdell savings can be used for tuition and fees, tutoring, books and supplies, uniforms and transportation. This action could save you thousands of dollars!
- Rollover: If you don’t want to mess with the Coverdell account and your child will go to college, you can roll the Coverdell money into a 529 savings plan at any time, penalty-free, as long as the accounts have the same beneficiary. If this is what you intend to do, you should plan to complete the rollover this year.
We don’t expect Congress to step in to renew the expiring provisions. However there is one provision that might be addressed: Starting next year, anyone who claims a higher-education tax credit cannot take a tax-free distribution from a Coverdell account in the same year, even for college expenses. Lawmakers may adjust that rule so that you can use both in the same year, but not to pay for the same expenses.
Questions or Comments?