A Tax-Friendly Way to Pay for School

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Question: Are there any tax-advantaged ways to save for high school expenses?

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Answer: Yes, a Coverdell education savings account lets you save up to $2,000 per beneficiary each year tax-free if the money is used for education expenses, from kindergarten through college. You can contribute the maximum to a Coverdell if your modified adjusted gross income is less than $95,000 for single filers or $190,000 on a joint tax return (you can make a partial contribution if your income is as high as $110,000 if single or $220,000 on a joint return). You have until April 18, 2017, to contribute for 2016.

For elementary and secondary school, you can withdraw money tax-free not only for tuition and fees but also for books, supplies and equipment, academic tutoring, and services for a special-needs beneficiary. You can also use the money for room and board, uniforms, transportation, and extended day programs if required or provided by the school. Coverdell money can also be used tax-free for a computer, related equipment and internet access for the student.

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The beneficiary must be younger than 18 when you make the contributions and must use the money before age 30. You can contribute to a Coverdell ESA even if you’re also contributing to a 529 college-savings account. If the child doesn’t use the money, you can choose another family member as the beneficiary.

Eligible expenses for college costs are similar to those for 529s, including tuition, fees, books, supplies and equipment, as well as a computer, software and internet access used by the student. Expenses for room and board count for college students who are enrolled at least half-time – up to the amount they pay to live on campus, or up to the amount the college counts in the cost of attendance for financial aid purposes if they live off-campus (this number may be listed on the college’s Web site, or you can get it from the college’s financial aid office).

Among brokerage firms and mutual fund companies that provide Coverdells, TD Ameritrade and Charles Schwab charge no setup or maintenance fees. Both offer the same investment choices as in their IRAs, including stocks, mutual funds, exchange-traded funds and other investments available to their brokerage customers (giving you more investing options in Coverdells than in 529s). TD Ameritrade has no minimum investment requirements. You need an initial investment of $1,000 to open a Coverdell with Schwab, which is waived if you set up an automatic monthly transfer of $100 through direct deposit or Schwab MoneyLink.

Fidelity doesn’t offer Coverdells, and Vanguard and T. Rowe Price no longer offer them (although it still services accounts that were established when it did offer them).

For more information, see IRS Publication 970 Tax Benefits for Education

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As the "Ask Kim" columnist for Kiplinger's Personal Finance, Lankford receives hundreds of personal finance questions from readers every month. She is the author of Rescue Your Financial Life (McGraw-Hill, 2003), The Insurance Maze: How You Can Save Money on Insurance -- and Still Get the Coverage You Need (Kaplan, 2006), Kiplinger's Ask Kim for Money Smart Solutions (Kaplan, 2007) and The Kiplinger/BBB Personal Finance Guide for Military Families. She is frequently featured as a financial expert on television and radio, including NBC's Today Show, CNN, CNBC and National Public Radio.