Smart Saving for College

College Savings Options


Coverdell Education Savings Accounts

Sunset Provision. Unless Congress takes action, certain provisions of the Coverdell will expire at the end of 2010. Specifically, the current $2,000 contribution will fall to $500, and expenses for K-12 will no longer be allowed.

Those who want more investment choices may want to consider Coverdell Education Saving Accounts (ESAs).

No Investment Restrictions
Formerly known as Education IRAs, ESAs are another tax-advantaged way to pay for college. Unlike 529 plans, your investment options are virtually limitless. Except for investing in life insurance contracts, you can buy and sell what you want whenever you want. Also, you can set them up at almost any brokerage firm, mutual-fund company or other financial institution.

Federal Tax Advantages
As with 529 plans, contributions are not deductible, but earnings in ESAs are tax-deferred, and withdrawals that are used for qualified education expenses are tax-free.

Education Expenses Covered
One advantage that ESAs have over other tax-advantaged saving options is that you can make tax-free withdrawals to pay for private elementary and high school expenses, as well as post-secondary school expenses. So if a private school is in the future, one option you might want to consider is saving for that expense in an ESA and using a 529 plan for college.

Contribution Limits
ESAs have two annual contribution limits for individuals:

  1. You can give up to $2,000 to any one beneficiary assuming you meet the ESA income limits discussed below.

  2. The total of all contributions to all ESAs set up for one beneficiary cannot exceed $2,000. If other family members set up ESAs for your child, you need to check with them to make sure this contribution limit is not exceeded.

If you exceed these contribution limits, there is a 6 percent excise tax each year on excess contributions.

Invest $2,000 a year at an annual yield of 6 percent from the time your child is born, and you will have a little more than $61,000 in college savings when your child turns 18. Can't save that much, or think you can get a higher return on your investment? Use our College Savings Calculator to estimate your savings.

Income Restrictions

A couple filing a joint return for tax year 20091 can contribute $2,000 if their modified adjusted gross income is less than $190,000 a year. The ability to contribute is phased out for couples filing jointly with modified adjusted gross incomes of between $190,000 and $220,000. Contributions are not allowed for couples filing jointly whose modified adjusted gross income is $220,000 or above.

Single taxpayers will be able to contribute $2,000 if their modified adjusted gross income is less than $95,000. Single taxpayers' ability to contribute is phased out if their modified adjusted gross income is between $95,000 and $110,000. No contributions are allowed if their modified adjusted gross income is $110,000 or above.

Organizations, such as corporations, can also contribute to ESAs and are not subject to any income limits.

Figuring Your ESA Contribution Limit. If your income is between $190,000 and $220,000 (joint filers), or $95,000 and $110,000 (single filers), you can figure your ESA contribution limit by using the following equations:

Married Joint Filers

$2,000 – (MAGI – $190,000) x $2,000 = Contribution Limit

Single Filers

$2,000 – (MAGI – $95,000) x $2,000 = Contribution Limit

Fees, Charges and Expenses
Fees, charges and expenses will vary depending on the investments you choose and the institution with which you open an ESA. Remember, however, that because of the fairly low contribution limits, even small annual fees or expenses could make a big difference in the value of your investment over time.

1 See IRS Publication 970: Tax Benefits for Education for 2010 updates.

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