Say college savings and most people will think of 529 plans. (Okay, if you’re thinking “what savings?” keep reading anyway.) But what about the lonely and unloved Coverdell? Might it be worth incorporating in a savings plan?
Neither the Coverdell (which used to be known as an Education IRA) nor 529 plans give you any tax deduction when you put the money in. The advantage of both of them is that, as long as the money is used for qualified educational expenses, the principal you deposited and any money you’ve managed to make on it comes out tax free.
Most planners, including me, will extol the benefits of a 529 plan: you can sock away a great chunk of money (maybe even enough to actually pay for the college expenses) and if you start early enough and we don’t have another market like 2008-2009, you might actually see significant gains in the account. If you live in a state that gives you a deduction on state income taxes, you might want to give some thought to the quality of that state’s plan and the worth of the deduction to you. However, there are at least one, and possibly two drawbacks to 529s: your investment choices are limited, and some management fees are excessively high.
If you’re used to wrestling with the investment choices in a 401(k) plan, you might be unfazed by the limited range of choices in some 529s. Before choosing a specific plan, be sure you know the range of investments offered. I’d advocate plans that offer a large variety of mutual funds with a company known for low costs (for example, Vanguard or TIAA-Creff), and, consistent with my investment philosophy, I’d choose index funds or ETFs in almost all cases.
So when might you look at a Coverdell? Well, the sad truth is that many people don’t save at all. If you are over 40, I strongly encourage you not to save ONE DIME for college costs unless you are already maxing out your 401(k), 403(b), Roth, SEP-IRA, traditional IRA and any other retirement savings open to you, are saving at least 10% of your income and have at least 3 months of living expenses (6 would be better) squirreled away. Actually, I’d say to do this even if you’re 25, but I know you won’t be scared enough until you’re waving at 40.
If and only if you’ve done that, then start a college savings program. A Coverdell has a limit of $2,000 in contributions for the year, and there’s an income ceiling as well, beyond which you cannot contribute. But for many people, $2,000 might be a do-able amount, an achievable goal, or even a palatable amount to touch the grandparents for. Two other advantages—a Coverdell can be invested in individual securities, so if you already have a good core portfolio of index mutual funds in a 529, the money segregated in a Coverdell might be used to play “casino”. Note that I would still advise that an index mutual fund portfolio is a far better and more prudent choice, but there’s always a few of you who like to take a gamble. Also, unless Congress changes things in two years, Coverdell funds can still be used to pay K-12 expenses, so if junior ends up at an expensive private school, you might already have funds saved.
Is it worth it to sock any money away if your little angel is already in high school? Probably—if you stagger withdrawals, the money might still be parked for 4 or more years, and can grow during that time. And if he or she decides to get a graduate degree in English or art history, well, you still may need it after that B.A. is in the leatherette case.
Is a Coverdell right for your family? Contact us for information on how an individualized college plan can give you answers.