Several clients have recently asked me about college saving plans. Here’s a bird’s eye view of two options: Coverdell and 529 Plans.
What are the similarities?
- Contributions have no federal tax benefit in the year when made.
- Earnings grow tax free.
- Earnings—at time of distribution—remain tax free when distributions are used for qualified education expenses.
- Distributions (or a portion of them) that are not used for qualified education expenses are subject to regular income tax rates, plus a 10% additional tax (penalty).
- Plan definitions for qualified higher education expenses have similar meanings.
- Qualified education expenses are reduced by other tax-free education assistance (including the American Opportunity Credit).
What makes the Coverdell unique?
- Are limited to $2,000 per year per beneficiary who is 18 or younger. Limitation applies to all contribution sources. See IRS Publication 970 for details;
- Are not allowed if modified adjusted gross income (MAGI) is $110,000 (or $220,000 if married filing jointly); and
- Are reduced if MAGI is between $95,000 and $110,000 (or $190,000 and $220,000 if married filing jointly).
- States do not allow a tax deduction for contributions
- Distributions can be used for elementary, secondary, or postsecondary qualified education.
- Investment advisors, banks, brokerage firms, and other companies often offer Coverdell savings accounts and can help you establish them.
What makes the 529 Plans (or Qualified Tuition Programs) unique?
- Contributions are not limited for federal purposes.
- States often do allow a tax deduction for limited contributions. Check your state’s requirements.
- Distributions can be used for elementary, secondary, or postsecondary qualified education. But there is a $10,000 maximum limit if used for elementary or secondary expenses. Note, distributions for elementary and secondary education is new to the 529 Plans as of 2018.
- A state offers and operates the 529 plan. You must work with the State to establish the plan. You do not necessarily need to be a resident of that State to establish, although a state income tax deduction may then not apply to you. Here is Wisconsin’s plan: http://529.wi.gov/.
Things to think about…
- If you want monies to be available for other life-events, you may want to consider other types of saving plans or investments for the beneficiary.
- Don’t forget federal tax gift limitations and requirements. For 2018, the annual gift exclusion is $15,000.
- Speak with your tax professional and/or investment advisor to aid you in determining if an education savings plan is right for you and your beneficiary.
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