Coverdell PlanPersonal Finance
A Coverdell Plan is highly similar to basic 529 savings plan. Coverdell plans are savings accounts with tax-sheltered returns and withdrawals. You fund Coverdell plans with after-tax dollars, which are grown tax-free. They are also withdrawn tax-free, but only when the withdrawal is applied to an educational expense. These can only be used at eligible education institutions, but they include a far wider variety of schools, colleges, and universities. You can use these programs at public or private elementary schools, secondary schools, colleges, and universities. There is one limitation; the school must be an accredited school in the state.
The wide variety of schools allows broader reach than most alternatives. The potential applications are also wider. You can pay for basic supplies, books, even electronics. It must be tied to the student’s education. The list of qualified expenses is as follows: Tuition, Fees, room, board, and equipment. The expense list is expanded for primary and secondary education: all previously mentioned items, books, tutoring, any special needs, education specific transportation, uniforms, related items, and supplements. It does not include sports or hobbies associated with education.
The Coverdell plan has a single individual who selects the investments. They also select the earnings and returns. Coverdell programs are not run by the state. You can open these plans at banks or brokerages. You can also acquire them through mutual fund providers. This allows you to select a provider that you are comfortable with. Your investment options change with your service provider. They typically offer Exchange Traded Funds and Mutual Funds. It may also consist of individual shares or bonds.
The person who creates the fund at these institutions is the primary caretaker of the plan. The Coverdell created to pay your child’s expenses has a single directing individual. If you create the plan for your child, you will be the director. You choose when to contribute money and how much. You will also pick the investments purchased and held. If necessary, you will decide when to rollover funds to another form of college savings plan, usually a 529 plan. When your child is above age 18, or a legal adult, they can become the custodian of the account.
There are limitations. You may only contribute if your modified adjusted gross income is under $110,000. Over this limit, you cannot contribute to a Coverdell plan. If you are filing joint returns with a spouse, you can contribute if modified adjusted gross income is under $220,000. As an important note, companies can also contribute money to Coverdell accounts and do not have these limits.
Another limit to be aware of is the maximum investment level per child. This program has an extremely low contribution limit, only $2,000 a year. Low contributions mean you need to start when your child is young. You can contribute $2,000 until your child hits 18. If you start when they are 12, you would only build a maximum principal pool of $12,000. If you started when they are born, your maximum potential principal would equal roughly $36,000. You will not be able to hit university savings with a Coverdell account. You must invest with a 529 or savings program to meet your savings goal. You can use both plans together. If you wish to contribute via a 529 plan and a Coverdell plan, note that you will be liable for gift tax if you donate over $14,000 total between the two plans.
There is an expiration date to your account. If you don’t use the account before the beneficiary reaches age 30. At this age, funds will be forcibly dispersed to them. This occurs within the first 30 days after their 30th birthday. Coverdell accounts dispersed this way are taxed at normal income rates with a 10% penalty. The only time a non-educational dispersal can occur without tax is disablement or death of the beneficiary. The 10% tax will also be avoided if the student receives a qualified scholarship or tuition waiver from a university.
Another way to avoid the 10% tax penalty is by rolling over your Coverdell into another Coverdell plan account. You can transfer the balance to another family member, but this must be finished within 60 days of initiating the process. This process is only valid for sons, brothers, daughters, sisters, nieces, nephews, uncles, aunts, and first cousins. The recipient must be under 30. The new beneficiary can rollover this plan to a 529 for themselves.
Coverdell & Financial Aid
Lastly, you should know how Coverdell accounts affect your child’s financial aid program. The assets in a Coverdell technically belong to the account owner, not the beneficiary. If the account owner is the beneficiary or student, the assets will affect their financial aid more than a third party owner. They may have their actual amount of financial aid acquired reduced. Third party Coverdell ownership will affect the student less than a parent or relative owning the account. However, Coverdell accounts will not impact the actual financial aid eligibility, since they do not count as income according to FASFA.
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