Saving for your children's college education is one of the most important financial tasks you will ever undertake. Luckily, you have plenty of savings options, most of them with tax advantages designed to encourage you to invest in your children's future. Consider a Coverdell education savings account (ESA):
These accounts give you both more and less flexibility than 529 savings plans. You can set them up for your child or children under 18 at any participating bank, mutual fund company or brokerage firm. Anyone can contribute to the accounts, but the total amount for each child cannot exceed $2,000 a year.
As with 529 savings plans, you don’t get a federal tax deduction on contributions to Coverdells, but your money grows tax-free, and you avoid tax on the earnings if you withdraw the money for qualified educational expenses. But with Coverdells, the term “qualified” covers a broader range of expenses, including private elementary and high school tuition. If you don’t use the money for qualified expenses, or if you don’t tap the account by the time the child turns 30, you must pay tax and a 10% penalty on the earnings.
To contribute, you need to have a modified adjusted gross income of no more than $110,000 as a single filer, or no more than $220,000 if you’re married filing jointly. (You can work around the income limits by establishing a custodial account for your child and using the money to contribute to the child’s Coverdell.) Current Coverdell provisions revert to less generous terms after December 31, 2010, unless Congress extends them.
Parent-owned Coverdells are subject to the same 5.6% assessment as other parental assets, according to the federal financial aid formula.