COVERDELLS VS. 529 PLANS

25 May COVERDELLS VS. 529 PLANS

There is more than one way to save for college for college.

With changes coming to Coverdell Education Savings Accounts in 2011, some parents are wondering if they should convert Coverdells to 529 plans. With that mind, here is a brief look at how both of these accounts work.

Why were Coverdell ESAs so popular in the past decade? Imagine a Roth IRA used only for college savings. That’s basically the concept behind a Coverdell. In fact, the Coverdell ESA (created in 2002) evolved from the Education IRA (created in 1998).

Contributions to a Coverdell ESA aren’t deductible, but you get tax-deferred growth. Withdrawals from Coverdells are (currently) tax-free if used for qualified educational expenses such as tuition, fees and books. The funds can also pay for certain K-12 education costs.¹ You can allocate Coverdell account assets among many different kinds of investment vehicles, and many banks, credit unions and mutual fund providers offer these accounts.

However, Coverdells have some drawbacks. The (current) annual contribution limit to a Coverdell is $2,000, and phase-outs kick in at $95,000 for single filers and $190,000 for married filers.²

Aside from a limit on annual contributions, there are also some age requirements. The Coverdell ESA beneficiary must be younger than 18 when the account is set up, and the money in the account must be spent or transferred before the beneficiary turns 30. At that point, the funds will have to be withdrawn and taxes and a 10% penalty may be assessed on the withdrawal. (If a beneficiary has special needs, contributions after age 18 and retention of the account assets after age 30 may be allowed – see IRS Publication 970 for details.)^1,2

Big changes are coming for Coverdells in 2011. Unless Congress intervenes, these accounts will be a lot less attractive next year. Beginning in 2011:

• The annual contribution limit drops from $2,000 to $500.
• A portion of the withdrawals will be taxed as ordinary income.
• A 10% penalty applies if a withdrawal is not used for education expenses.
• No withdrawals may be used to pay K-12 education expenses.^3,4

All this has many parents thinking about shifting their Coverdell funds to a 529 plan.

Thinking of moving Coverdell assets into a 529? You can do a rollover from a Coverdell ESA to a 529 plan without incurring any tax penalties as long as the 529 plan will have the same beneficiary as the present Coverdell account.⁴

Under federal tax law, withdrawals from a 529 plan are tax-free – assuming they are used for qualified education expenses – but contributions are taxed. (Some states do give you a break and let you deduct part of your 529 contribution from state tax returns.)^4,5

You can go one of two ways with a 529:

• You can prepay tuition at today’s rates (at a qualifying college or university) through a 529 prepaid tuition program.
• You can save to pay tomorrow’s college tuition through a 529 savings plan which gives you tax-deferred growth. Most people prefer this option for its flexibility and asset accumulation potential.⁶

You can put much more money into a 529 annually. You can put up to $13,000 in a 529 plan this year without having to file a gift tax report.Your spouse can, too. So can your relatives. So can anyone: any individual taxpayer can contribute up to $13,000 to a 529 plan in 2010. In fact, a taxpayer can pour in up to five years worth of contributions in one year – currently, that’s $65,000 – if that taxpayer refrains from making further contributions for the next five years. While these contributions will reduce your $1 million lifetime federal gift exemption, they can also obviously be useful in estate planning.

In 2010, most 529 plans allow annual contributions of more than $230,000. Some have “lifetime” limits on the total contribution. All 529 contributions must be in cash.^6,7

A 529 plan has no phase-outs. You are never too rich to contribute to a 529 plan. 529s do not have any form of income restrictions.⁷

Other nice features. The owner of a 529 plan retains control of the assets and has the power to change the beneficiary. You can even start multiple 529 plans.⁸

In many respects, 529 plans have left Coverdell ESAs in the dust.

Here comes 2011. As the calendar pages turn, you may want to consider a move from a Coverdell ESA to a 529 plan. You certainly will want to keep up with developments affecting these accounts and other education savings options. Your financial consultant can help you stay informed.

Kevin M. Nast is a Financial Planner and the President of NastGroup Financial in Northville, MI 48167. He may be reached at nastgroupfinancial.com or 248.347.1888. Kevin also services clients in Commerce Township, West Bloomfield, Farmington Hills, Bloomfield Hills, Auburn Hills and the surrounding metro Detroit area as well as 13 additional states across the US.

A “529 Plan” is a generic term for a “qualified tuition program” established under Section 529 of the Internal Revenue Code. Investors should consider the investment objectives, risks, and charges and expenses associated with 529 Plans before investing.  More information about 529 Plans is available in the issuer’s official statement.  The official statement should be read carefully before investing.

This material was prepared by Peter Montoya Inc., and does not necessarily represent the views of the presenting Representative or the Representative’s Broker/Dealer. This information should not be construed as investment advice. Neither the named Representative nor Broker/Dealer gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The publisher is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent professional. Please consult your Financial Advisor for further information.. www.petermontoya.com, www.montoyaregistry.comww.marketinglibrary.net

LD38388-10/10