Education Planning: Is The End Near for Coverdell Accounts?

The Coverdell Education Savings Account is unique in that it provides tax breaks to families setting aside money that can be used to pay for a private education from kindergarten through high school, as well as for college expenses. However, with the Coverdell’s popularity fading in recent years, and the law enabling its tax breaks set to expire at the end of 2012, questions loom about the future of the accounts.

Covering Coverdells

Coverdells are qualified investment accounts that allow nondeductible contributions of up to $2,000 annually per beneficiary. Earnings in the account are not taxed, and as long as withdrawals are used for qualified education expenses, they are tax free as well. Assets in a Coverdell must be used before the beneficiary’s 30th birthday. The designated beneficiary of a Coverdell account is free to take withdrawals at any time, but any amount in excess of his or her qualified education expenses will be taxable as income. A 10% additional federal tax may also apply.

Coverdells also have a special feature unavailable with 529 college saving plans: In addition to college, qualified withdrawals may be used to pay for elementary and/or secondary school expenses. In addition, unlike 529 plans, Coverdells impose income eligibility limits on contributors. Single filers with modified adjusted gross incomes of more than $110,000 and joint filers with incomes of more than $220,000 cannot contribute.

According to a report in The New York Times, the number of tax returns mentioning contributions to a Coverdell fell from 985,000 in 2005 to 644,000 in 2009. The IRS does not track the exact number of taxpayers who use the accounts for a K-12 education.

The deadline to contribute to a Coverdell is generally April 15, the same deadline that applies to IRAs. Before making a decision about a Coverdell, evaluate the investment options, fees, and services offered by competing financial institutions that provide the accounts. Also, bear in mind that current rules governing the Coverdell Education Savings Account will expire at the end of 2012 unless Congress acts to renew them.

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