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Tuesday, December 21, 2010

Coverdell Update

I have great readers, with great suggestions, and great questions. Julie writes:

While we are asking questions, what is the status of the Coverdells? Are they part of the Bush tax cuts that will continue for the next two years? Will we still be able to use them to fund private school education K-12? Does the old limit still apply?

I'm going to forgo writing my own post and pointing readers to one of the excellent financial sites out there, Saving for College (division of Bank Rate) on the Coverdell Fade-Out.

Certain Coverdell provisions are scheduled to sunset if Congress does not vote to extend certain provisions such as the ability to use the Coverdell for private K-12 education. Should Congress not extend the Coverdell in its current form, contributions will be further limited from $2000 a year to $500 and funds will be restricted to college expenses only after December 31, 2010.

Some will roll their tax advantaged Coverdell IRA into a 529 College Savings Plan. Others might leave their Coverdell in place. Some might spend their funds (and quick).

We will be leaving our Coverdells in place. Investing is not my strong point, but I like the flexibility to invest in a whole host of funds, which is not possible under the 529 plan. Having both the Coverdell and a 529 for my children gives us a chance to diversify what investments we do make. While I am sad that the gains will (likely) no longer be available for K-12 expenses, when the market bottomed out, I already mentally wrote off being able to use these custodial accounts for K-12 expenses. I'm not willing to take a loss when we can expand our investment time frame and come out ahead. So, college it will be! Thankfully I wasn't counting on spending this money in the near future. When we move money into restricted accounts, we play the mental trick of "forgetting about the money."

Check out the Coverdell fade-out article and let me know your plans if you own Coverdell accounts.


Critically Observant Jew said...

Seems that Coverdell $2k extension is included in the tax bill signed into law on 12/17/2010:

does not seem like k-12 provision is included in there as well. But I'm with you on expanded options for Coverdell as opposed to 521 plans. For me it makes more sense contributing to Coverdell than to 521. Also, in Illinois, where there's a state tax deduction for contributing to state's 521, you can convert the Coverdell to 521 a year or so before intended funds' use and get the deduction on the original principal amount. That's what I plan to do when the time comes (and laws don't change).

Critically Observant Jew said...

Seems that k-12 provision is still there - so there're 2 more years to spend Coverdell on yeshiva tuition for those to whom it applies.

Frum Financial Planner said...

I have seen many stories in the press in recent months stating since the Coverdell limit will be returning to $500 in 2011 (which in fact won't be the case as the Tax law recently passed extends the $2,000 limit 2 more years) that you should roll over your Coverdell to a 529. I agree with you that there is no reason to do this. Coverdells will still be able to be used for college expenses just like 529s. I do admit that Coverdells aren't as good as before for frum people since they can no longer be used for private K-12 education. The other main advantage of Coverdells over 529s is the freedom to invest in anything you want such as low cost index funds with Vanguard. This is less of an issue now-a-days as many 529 plans now have every low expenses. For examples the NY Direct 529 plan recently cut its expense ration in half from .50% to .25% which now means NY has one of the best 529 plans in the country (and it’s also state tax deductible for those who live and/or work in NY State). One thing I actually like better about 529s over Coverdells is that it takes less money in your 529 account to be properly diversified than it does for Coverdells because 529s work similar to 401ks in that there is no investment minimums and that you can build up your fund with as little as $25 a month and you can invest that small amount in a number of funds to get exposure to broad asset classes which over time increases your return while reducing your risk. A Coverdell, on the other hand, would generally require a higher minimum per fund (of course there are ways to get around that but for a novice investor a 529 offers the easiest way to properly diversify your investments).

One thing to keep in mind if you do roll your Coverdell into a 529 is not you won't be able to change the beneficiary as you can normally do with a regular 529 account since the Coverdell is an account with a named beneficiary which can't be changed.

I am a frum financial planner and just recently assisted a frum client to liquidate his Coverdell so that he can take the money out without paying taxes this year (since he paid more than he took out in K-12 tuition this year). He then opened a regular taxable account at Vanguard. The reason I advised him to do this is because he wasn't using the money in the Coverdell to save for education rather to save for Bar/Bas Mitzvahs. I had initially advised him to have his simcha fund as a Coverdell so he would avoid taxes (as he will be paying K-12 tuition the same years that he will making the Bar & Bas Mitzvahs).