Coverdell Education Savings Accounts

The reality of college costs today: Students at a four-year public college (2000-2001) pay, on average, around $3,500 per year in tuition. Room and board run up the one-year bill to $8,500. If you throw in $1,500 for miscellaneous expenses, you face annual costs of $10,000. The total one-year tab at private schools averages about $26,000.¹

¹ "News 2000-2001: Modest Rises in Tuition...," College Board Web site: www.collegeboard.org.

That's just one year. Multiply that number by at least four. This brings total projected costs to $40,000 at a public university and more than $100,000 for a private education.

Inflation can add despair to frustration. Look at the numbers at even a modest 3% inflation rate: If your little scholar will be college bound in five years, today's estimated $40,000 annual bill could be $46,400; in ten years it could reach $53,800. And if you dream of your three-year-old heading off to State U at age 18, the projected annual cost could hit $62,400.²

² These are projected costs, based on inflation estimates, and do not reflect actual costs of a particular institution.

Other factors: These projections do not factor in (A) that you may have more than one child; (B) the cost of graduate or professional school; or (C) that it is not uncommon for some students to take up to five years to complete a four-year program.

Conclusion: The best way to help meet these costs is to map out a college funding strategy. Whether your child is still in diapers or already borrowing the family car, there are steps you can take to soften the blow of college costs.

Steps to consider:

• If you qualify, start a Coverdell Education Savings Account. Beginning in 2002, you may be able to contribute up to $2,000 a year, depending on your income. Make it the cornerstone of your college fund strategy.
• Supplement the savings account with other savings.
• See if you qualify to take advantage of grants, scholarships, credits, deferred-loan programs and other ways to help reduce college costs.
• Insure your ability to help pay your children's college expenses. Your role in providing financial support is important. Life insurance can help assure that, if you die and, as a result, your income is lost, your children's dreams of college degrees need not be lost as well.

The key: Get started. Your children aren't getting any younger and the cost of an education isn't getting any lower.

More on Coverdell Education Savings Accounts

If you meet the income requirements, you can make a Coverdell Education Savings Account the cornerstone of your plan. Created by Congress in 1997 as Education IRAs and renamed in 2001, Coverdell Education Savings Accounts permit contributions of up to $2,000 each year in the name of a qualified beneficiary under age 18. Anybody who qualifies can make the contribution (you, a grandparent, favorite uncle, etc.) provided the total does not exceed $2,000 per child per year, beginning in 2002.

Contributions are not tax-deductible. However, earnings are tax-deferred, and distributions are tax-free if the money is used to pay qualified education expenses (which include tuition, fees, books, supplies, equipment, and certain room and board expenses). If distributions are greater than the qualified education expenses in a year, then a portion of the distribution is subject to income tax plus a 10% additional tax penalty (some exceptions may apply).

Example: Lou and Joyce want to do something for their two grandchildren, Emma and Athena, who are both under age three. With the blessing (and appreciation) of the children's parents, Lou and Joyce contribute $4,000 annually ($2,000 for each grandchild) into Coverdell Education Savings Accounts. By the time their grandchildren are ready for college, at least part of the cost will be taken care of.

How much can you accumulate? The total amount may not knock your socks off. Still, it falls under the category of every little bit helps.

There are limits and restrictions: The contributor (if married, filing jointly) can have an adjusted gross income of no more than $190,000 ($95,000 if single) before the contribution amount begins to decline. It is phased out completely at $220,000 and $110,000 respectively.

However, if you do not qualify, contributions can still be made in your child's name by others. Also, it is possible under current law to gift the contribution to the child, who then makes the contribution in his or her own name.³ This can make a Coverdell Education Savings Account an excellent gifting vehicle for grandparents and other relatives.

³ "All About IRAs," by Roy Lewis. Web site: www.fool.com/money/allaboutiras/allaboutiras.htm.

Other restrictions:

• Beginning in 2002, the amount that can be received tax-free from a Coverdell Education Savings Account must be reduced by the amount of qualified education expenses used in claiming a HOPE credit or a Lifetime Learning Credit.
• If the money is not used by the named beneficiary, of if the beneficiary turns 30 or dies, the Coverdell Education Savings Account can be rolled over without income taxes or tax penalty to another Coverdell Education Savings Account for (A) your other children; (B) your child's children; or (C) your other children's children.⁴ The new beneficiary generally must be under age 30, and the rollover must occur within 60 days of withdrawal. Only one rollover may be made during any 12 month period.
• If a distribution is not used for qualified education expenses, the taxable amount may be subject to a 10% penalty in addition to income taxes.
• Special rules apply to "special needs beneficiaries."

⁴ Donald F. Cady, J.D., LL.M., CLU, Field Guide To Estate Planning, Business Planning, & Employee Benefits (Cincinnati: National Underwriter Company, 2000) 351.

The key to meeting college expenses is to have a plan. If you qualify, consider making a Coverdell Education Savings Account the cornerstone of your plan.

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