[EXTENDED] The Best Way to Plan for Your Child’s Future
Dear Rich Lifer,
In a recent update, I told you how the new CARES act has substantially changed many of the retirement rules we’ve come to know and love … at least temporarily.
One of those changes was the deadline to fund various retirement accounts, including IRAs.
Normally, you’d have to put your 2019 contributions in by April 15th.
Now, you have until July 15th.
Of course, one thing I didn’t mention is that this same deadline change will also apply to Coverdell ESA accounts – my preferred way to save for my daughter’s future college costs.
I’ve been using one of these accounts ever since she was born in 2007 … and the account’s value has been growing as rapidly as she has!
So if you have a child in your life — whether it’s a son, a granddaughter or even a niece — I strongly suggest you take a closer look at opening one of these accounts, too.
And you now have even more time to do so.
Given the market pullback, this is an ideal time to start (or continue) contributing … especially if you put the money into stock-related investments.
Just to review what these accounts are all about …
The Best College Savings Plan Around
What is now called a Coverdell Education Savings Account used to be known simply as an Education IRA.
I guess lawmakers later decided that calling it a retirement account was silly, since these things have to be used by age 30.
Either that or they were looking for something to name after yet another U.S. senator! (In this case, it’s Paul Coverdell of Georgia.)
Of course, no matter what you want to call it, Coverdell accounts do function very much like Roth IRAs designed for young students.
Like Roth IRAs, they allow you to sock away money — $2,000 a year, in this case — by tax day (which as previously mentioned is now July 15th for the 2019 fiscal year).
And like Roth IRAs, as long as the funds are used for the benefit of schooling costs, any returns earned in the account will be distributed free of additional taxation going forward.
At least that’s how it works under current law.
Now, I know $2,000 a year isn’t an eye-popping number. But it’s still a nice start and will add up over time. Plus, it’s perfect for using any tax refund money you may have already received.
Meanwhile, don’t underestimate the benefit of this tax shelter.
Let’s say you happened to put $2,000 into your child’s Coverdell account and invested it so wisely that, within 10 years, it had miraculously turned into $200,000.
That full amount would be available to pay for your kid’s education — and not one penny of taxes would be owed as you pulled the cash out!
Another cool feature of Coverdell accounts is that they can be used for expenses related to all types of schooling: high-priced pre-K classes, private secondary education, and many associated costs such as computers and books.
What About Income Restrictions?
Well, like the Roth IRA there are some caps to be aware of …
Technically, you cannot fund a Coverdell if you have a modified adjusted gross income (MAGI) above $110,000 filing singly or $220,000 married filing jointly. Phase-outs kick in at lower levels, too.
But here’s where it gets interesting — even a child with no earned income can contribute to a Coverdell!
So if you’re above the income threshold, you can just gift the $2,000 to the child under the Uniform Transfer to Minors Act … and they can put it in the Coverdell themselves.
Yes, it’s a stupid formality. But if it works in your favor, go with it!
And again, please note that you can establish a Coverdell for ANY child in your life — not just a direct relative but even a friend’s child or grandchild. Corporations and trusts are also free to establish Coverdells.
Important Features to Consider…
The only thing to know is that the Coverdell’s beneficiary can only have $2,000 contributed to his or her account in any given year.
So you should always ask whether an account already exists and how much has been deposited before establishing one on your own. Contributions must also be made before the beneficiary turns 18.
As I noted earlier, a Coverdell beneficiary has to use the funds before turning age 30, or else taxes and penalties will likely be owed.
However, the account can always be switched to another beneficiary before then — even if the new recipient is between ages 18 and 30!
Bottom line: You don’t get the potential for tax deductions that you do with some other accounts like 529 plans.
But Coverdells are a unique way to sock away a little extra money for someone special.
And they can be fully funded in addition to 529 plans. So if you’re an aggressive saver and planner, they are definitely worth investigating no matter what.
If you’re interested in establishing a Coverdell, just check with your regular brokerage house or other financial institution.
Most offer them, and it’s just a matter of completing some simple paperwork.
To a richer life,