In my last blog article I discussed the rising cost of college tuition and the myriad ways that parents and students are choosing to pay for it. In light of a recent Wall Street Journal article, I’ll begin my in-depth discussion of four college savings plans with the Coverdell Education Savings Account (ESA). The story indicates that in addition to paying for college tuition, parents are now beginning to borrow money en masse for private secondary education. This trend is being driven by groups of middle class parents who feel that the public schools in their area are not providing a sufficient level of education for their children.
The ESA would have been an attractive savings plan for these parents because it can be used to pay for private primary and secondary education, not just college.
The ESA allows up to $2,000 a year of non-deductible contributions into the account per student. This money will grow tax deferred and can be distributed tax free as long as it is used for qualified educational expenses such as tuition and fees, required books, supplies and equipment and qualified expenses for room and board. If the distribution exceeds the qualified expenses an additional 10% tax penalty will apply.
If any funds remain when the beneficiary reaches the age of 30, the funds must be distributed within 30 days and the earnings will face an additional 10% tax penalty. Alternatively, the account can be transferred to another family member in order to avoid these taxes.
The upside of this account is the flexibility of investment choices. When opening an ESA, you can choose from a wide array of investment choices; work with your financial advisor to see which option is right for you. Unlike other plans we will be discussing in the coming weeks, this is an attractive option to help keep your fees and expenses down, since you can control the investment portfolio yourself.
The downside of the ESA is the relatively small contribution that is allowed each year. $2,000 is a good start, and may be sufficient if the parent or grandparents start saving at a very early age, but with tuitions heading skyward this may not cover even the first year of higher education.
As the years go by and the child nears their college years, you can help mitigate your investment risk by scaling back on the aggressiveness of the account. It may be hard to recover from a significant market correction the closer you get to enrollment.
So it may be wise to start here, and then look at other options to continue your savings plans. We’ll talk about more over the next three weeks. As always, it is best to seek out the advice of a qualified financial professional to help structure an optimal investment portfolio.