Q. I read last week’s column and think you may have given some incorrect information about Coverdell IRAs. A few years ago my custodian for my children’s (ages 5 and 7) Coverdell accounts said they were no longer accepting contributions to a Coverdell because the attractive benefits of the Coverdell Education Savings Accounts (ESAs) would expire at the end of 2012.
They suggested I roll the funds to a 529 plan but I never got around to doing so. Are you familiar with the changes, and did they go through? If so, should I roll the funds to a 529 plan or just leave the Coverdell IRAs until I need the money?
A. You are correct that, because of possible changes to these educational savings accounts, some providers stopped accepting new assets or opening new Coverdell IRAs. If not for the fiscal cliff deal, contributions for a beneficiary would have been reduced from $2,000 to $500, expenses for kindergarten through the 12th grade would no longer be covered and a contribution to both a 529 plan and ESAs for the same beneficiary would no longer have been allowed in the same year.
Congress saved Coverdells before as part of the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010, and the new rules in the American Taxpayer Relief Act preserve some of the attractive features to help parents with the cost of education from elementary through college years. You may want to contact the custodian and see whether they will allow contributions now that the benefits of this savings plan have been preserved.
I would not transfer the monies in the Coverdell to a 529 plan. The money in a 529 plan receives tax-favored treatment only if used for qualified higher education expenses. Money from a Coverdell can be used for any primary, secondary or college education-related expense. If your child needs a tutor, computer, printer, etc. prior to college, the funds in the Coverdell may come in very handy. You can use both the Coverdell and 529 plans in conjunction for college expenses but not for the same expense.
If you have a special needs child, the Coverdell has an additional advantage. For most, any balance remaining in the Coverdell account must be distributed once the beneficiary reaches age 30. For special needs children, the accounts can be kept open, continuing to grow tax free with no age limit.
If the only goal is to save for college, make future contributions to a 529 plan. These plans offer tax-advantage savings and, depending upon the state in which you live, it may provide tax incentives for contributions. The North Carolina plan offers a tax deduction for contributions up to $5,000 for married couples filing jointly and $2,500 for those filing as single or head of household. The North Carolina plan can be used to pay qualified education expenses at colleges and universities throughout the United States (cfnc.org).
As suggested last week, if funds are limited, funding your Roth IRA may be the best option. Contributions are not tax deductible but the investments grow tax deferred and are tax free when taken out at age 59 1/2 or after. Your contributions can be taken out at any age without a 10 percent early-withdrawal penalty or income tax.
If needed, you could use your contributions for your children’s education. If not needed, you are that much more prepared for retirement.
Holly Nicholson is a certified financial planner in Raleigh. She cannot answer every question. Reach her at askholly.com or P.O. Box 97128, Raleigh, NC 27624