ESAs May Provide the College Savings Solution Your Children Need

The cost of education increases every year, and many parents are asking themselves, "How expensive will college tuition be when our children turn 18?" And more importantly, "How will we afford it?"

For many families, the answer is a Coverdell Education Savings Account (ESA), which allows an adult ("responsible individual") to invest money for the future educational expenses of a child ("beneficiary"). ESAs function much like Individual Retirement Accounts (IRAs), but with a different savings purpose and a structure designed specifically for education savings.

At Scottrade, no-fee ESAs may be a logical and practical first step toward saving for the future educational expenses of the children in your life.

Before making that decision, it's important to research Coverdell ESAs to determine if they're right for you. To help, Marcia Bequette, Scottrade IRA Manager, offers some more detailed information about ESAs in the form of advantages and disadvantages:

Advantages

• Tax-free withdrawals. Contributions to ESAs are not tax deductible and contributions must be made after-tax, but when the money is withdrawn, it can be withdrawn tax-free as long as it is being used for qualified educational expenses*.
• Investment freedom. Responsible individuals can set up a child's ESA by selecting investments, much like they would with an IRA. This is a distinct difference between ESAs and state-run 529 plans, which are also education savings plans.
• Variety. The list of expenses that qualify as educational could be considered very generous. Everything from trade schools to primary education to learning tools like computers are eligible expenses* for the money in a child's ESA.
• Flexibility. Anyone can open an ESA for any child, but the responsible individual is generally a parent or legal guardian. Also, the beneficiary (child) can transfer unused funds to the ESA of a qualified family member*, including children, siblings, in-laws, step-parents, first cousins and spouses.

* For a complete listing of qualified education expenses and qualified family members to whom the ESA can be rolled over, please see IRS Publication 970.

Disadvantages

• Income limit. Just like Roth IRAs, responsible individuals must be below a certain modified adjusted gross income (MAGI) level to contribute to a child's ESA. For a single filer, MAGI cannot exceed $110,000, and for joint filers, MAGI must be under $220,000.
• Contribution limit. Even if income restrictions are met, responsible individuals may not contribute more than $2,000 a year to a single ESA. And, contributions may not be made after the child turns 18.
• Withdrawal penalties. Withdrawal of ESA money for purposes other than paying for qualified educational expenses will incur penalties from the IRS. Additionally, the IRA will impose penalties if all of the money in a child's ESA is not withdrawn for educational purposes by the age of 30 (except for children with special needs).
• Confusing language. Many people find ESAs difficult to understand because the documents themselves are written in a way that can be confusing.

Cost of Waiting

No matter what type of educational savings plan you choose, Bequette recommends you start early and contribute regularly.

"Long-term, consistent contributions are the best way to take advantage of educational savings plans," Bequette said. "The difference in money saved over 17 years versus say, 10 years, can be dramatic."

Bequette calculated a hypothetical example showing that a responsible adult making the maximum $2,000 contribution every year for 17 years beginning on a child's first birthday ($34,000 total), assuming an annual return of 6.5%, will have saved $61,854 by the time the beneficiary starts college. But, an adult who waits until the child is 10 years old to begin investing will only end up with $20,913 saved, assuming the same contribution and return rates.

To learn more about no-fee Coverdell ESAs at Scottrade, please see our brochure or contact your local branch office.