Coverdell accounts are special educational savings accounts that help you save up for your child's educational expenses. You might hear them compared to 529 plans, which are specifically designed for college savings. Coverdell accounts, on the other hand, are meant to help you support your child from elementary school through college.
But are they the best idea in terms of a savings plan? Is there a way to make your money work harder for you?
The Basics: Coverdell Educational Savings Accounts
When you open a Coverdell account, you're limited to a $2,000 yearly contribution. You can't deduct those contributions on your taxes, but the government is giving you a bit of a break. The money you put in the account will grow tax-free through compound interest until you pull it out. Your student won't have to pay tax on that money when they receive it as long as the amount they get is less than their total educational expenses.
What's the Catch?
Like a 529 plan, your student can only use the money on qualified educational expenses at an eligible school. Tuition, books, computers, educational software, and "qualified expenses" for room and board is the limit of what your student can use this money for. In other words, what happens if your student drops out of college...or decides not to go at all? If life takes them in a different path, what happens to all that money?
To avoid any IRS taxes or penalties, you can roll one child's Coverdell account over to another child. If the account still has money in it when your child reaches age 30, it will need to be distributed to close the account. At that point, the money that account has earned in interest is taxable, plus subject to a 10% penalty.
Is There Another Option?
Other than 529s, which have a lot of the same limitations, you do have another option. Permanent life insurance policies build cash value that lets you do all of the same things a Coverdell or 529 can do, but without any penalties.
The cash value you build can be used for anything. Tuition, room & board, transportation expenses...or travel, starting a new business, supplementing your retirement, and more! There are absolutely no limitations on what you can do with that money. It lets you support your children...and yourself...based on your needs now, not what you thought your needs were 10 or 15 years ago.
Plus, you get the peace of mind that comes with knowing that life insurance will pay out when the time comes. Not only does it give you a financial boost during your life, but it gives your beneficiaries a boost after you're gone. It can help your kids get an education now, and provide them with an inheritance later. This is why more and more families are turning to life insurance as a Coverdell or 529 plan alternative.