Education

Coverdell and 529 Plans

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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?

  1. Contributions:
    • 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). 
  2. States do not allow a tax deduction for contributions
  3. Distributions can be used for elementary, secondary, or postsecondary qualified education.
  4. 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?

  1. Contributions are not limited for federal purposes.
  2. States often do allow a tax deduction for limited contributions. Check your state’s requirements.
  3. 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.
  4. 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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