Education Savings Account
A popular college savings plan is the Education IRA. The Education IRA was renamed the Coverdell Education Savings Account (ESA) in 2002. An ESA account allows for an annual non-deductible contribution of up to $2,000 per child. These contributions are made to a designated investment trust account. The account grows tax deferred and, if used for education expenses, withdrawals from the account are completely tax free.
While ESA’s are primarily used for college planning, certain K-12 expenses were added to the list of qualified expenses in 2002. There are a few key rules for Education Savings Accounts. Tax law prohibits funding an ESA once the beneficiary reaches age 18. Many different family members can contribute to the same ESA but the annual contributions cannot exceed $2,000. The contributions and subsequent account values are eventually distributed to the child if not used for education. This is different from a 529 savings plan where the parent retains control of the asset. The account must be used for education expenses or distributed to the intended beneficiary before the age of 30 or there are taxes and a 10% penalty due. Exceptions to the 10% penalty include the death or disability of beneficiary or if the beneficiary receives a qualified scholarship. ESA accounts are considered an asset of the custodian (typically the parent) when applying for financial aid. In addition, another main benefit of ESA accounts are that they typically have very low administrative expenses. The Hope and Lifetime learning credits can be claimed in the same year the beneficiary takes a tax free distribution from a Coverdell Education Savings Account.
Financial planning for college is a goal of most parents today. Often times, parents are torn between saving for college and planning for their own retirement. The cost of college is increasing. By preparing early, parents can more easily put away enough money on a monthly or annual basis to cover most, if not all, college expenses. In addition, many parents would like to send their children to private elementary, middle, and high schools. An ESA account can help to cover the costs of these as well.
At Clay Northam Wealth Management services we specialize in financial planning for college. Please contact us at our El Segundo or Seal Beach locations regarding college planning.