In May, we kicked off our monthly College Savings series by talking about the pros and cons of a 529 plan. This month we continue the series by discussing Coverdell Plans and UTMA & UGMA Custodial Accounts.
Formerly known as an education IRA, a Coverdell ESA (Education Savings Account) is another savings account set up to pay for education expenses of a designated beneficiary, but it’s not just limited to college expenses.
- May also be used for primary and secondary education. If you have a K-12 child enrolled in any public, private or religious school, Coverdell funds covers things like tuition and fees, books, supplies and equipment, tutoring, uniforms, and more. (View the complete list of qualified expenses here.)
- You choose your investment vehicle. Invest in a wider array of options, including stocks, bonds, and mutual funds. Or diversify among several of these.
- Tax-free earnings and distributions. As long as Coverdell cash is used for qualifying education expenses, the earnings grow tax-free. And as long as distributions do not exceed the beneficiary’s qualified education expenses for the year, distributions are tax-free as well.
Things To Consider:
- Annual contributions are limited. While anyone can contribute to the beneficiary’s Coverdell account, and you can open more than one Coverdell account in a beneficiary’s name, contributions are limited to a combined total of $2,000 per year.
- Funds must be used by age 30. If the beneficiary does not use the funds by the time they’re 30, they will owe tax on the earnings in addition to a 10% tax penalty. This can be avoided by rolling over the funds into a relative’s Coverdell plan (see qualifying family member list).
- There are income limits. Your adjusted gross income cannot exceed $110,000 (or $220,000 if filing jointly). However, organizations may contribute regardless of their annual income.
UGMA & UTMA Accounts
While they are a mouthful, the Uniform Gift to Minors Act (UGMA) and Uniform Transfer to Minors Act (UTMA) are your standard custodial accounts. They are assets held in a child’s name that they would not normally be able to own until they reach their state determined legal age (e.g. stocks, bonds, mutual funds, annuities, and life insurance policies). What makes them different is the type of securities covered – UTMAs can include property like real estate, fine art, and large inheritances.
- Favorable tax rate. Commonly dubbed the “kiddie tax”, a certain amount is non-taxable and then taxed at a lower tax rate because the account is in a minor’s name. This tends to be more favorable than being taxed at mom and dad’s rate.
- Can be used for any purpose. Funds are not limited to college education expenses. Withdrawals can be made when the child is still a minor to help pay for expenses that benefit them, which certainly includes primary and secondary education.
Things to think about:
- Can be used for any purpose. You’ll notice this is listed as both a pro and a con. It depends on how you look at it, really. Once a child turns legal age and has full access to their UGMA/UTMA investment accounts, they can use those funds for whatever they please. You don’t have any control over the funds at this point. So while you can hope the funds are put toward something beneficial like education or maybe even real estate…if Junior wants to buy a boatload of beanie babies, he can.
- Counts against financial aid. Because these custodial accounts are considered assets of the student, they impact financial aid eligibility. However, UGMA and UTMA investors are more often than not wealthy enough to not have to worry about getting “needs” based financial aid.
Whether you have a lump sum to invest or want to add to a college savings plan monthly, I can help weigh your options and explore a variety of savings possibilities. Meetings are always free for ECCU members…schedule one today or shoot me an email with your questions.
Our next post will cover the pros and cons of good ol’ fashioned Savings, CDs and Savings Bonds. Be sure to subscribe below to our weekly blog updates so you don’t miss it!