College Savings Tools: Coverdell and 529 Plans
Over the past 30 years the cost of attending college has increased faster than the pace of inflation in the United States. Data suggests that the rate tuition has increased is close to 8% per year over that period of time. A child born today that would like to attend a private school that cost $30,000 a year will see that cost rise to over $119,000 just for the first year.
Financing for a college education typically comes from current income of parents, relatives and the student. Student loans, pre-paid tuition programs, grants and scholarships are available as well as parent's and relative's savings. Two commonly used savings and investing vehicles for college expenses are Coverdell Education Savings Acocunts and 529 Plans.
- Coverdell Education Savings Accounts were created by congress in 1997 and were called Education IRAs. These plans have a $2,000 annual account contribution limit per beneficiary which is subject to modified adjusted gross income limits. Money in the accounts grows income tax free and withdrawals made for qualified education expenses are not taxable. Coverdell accounts can be used for elementary, secondary, college and special needs student expenses. Money in these accounts must be used by the time the beneficiary reaches age 30. Contributions phase out for a single parent with adjusted gross income of $110,000 and $220,000 for parents filing jointly.
- 529 Plans have become increasingly more popular as the vehicle of choice for education savings planning. Section 529 Plans are education savings plans operated by a state which offer tax-deferred savings on money in the account as well as tax free withdrawals for qualified higher education expenses for the account beneficiary. Contributions are not deductible. The account owner controls the distribution of the funds in this account. These accounts allow for substantially larger savings limits (more that $300,000 in some states) and contributions are not subject to adjusted gross income levels. Contributions need not come from the same state the plan is sponsored by. Some states allow for in state tax deductions if you use the plan from the state in which you reside. If the primary beneficiary decides not to go to college the beneficiary can be changed tax-free. The law also provides for rollovers from one plan to another should the owners decide that their current plan is no longer for them. 529 Plans have added estate planning benefits. Subject to the gift tax limits each year a person (typically a parent or grandparent) can gift the beneficiary the maximum gift amount, currently $14,000. A married couple (parents or grandparents) may gift up to $28,000 for the year based on gifting $14,000 per spouse. Additionally these plans allow for the 5-year accelerated gift option allowing for greater lump sum contributions of 5 years of gifting per individual which can be of great benefit for estate planning as these assets are considered to be held outside of the contributors estate. There are no limits on the number of plans you can set up and you can name anyone as a beneficiary. Keep in mind that distributions that do not pay for qualified higher education expenses will likely be taxable as ordinary income and maybe subject to a 10% additional tax.