Tuesday, June 26, 2007

A Little Bit of Help for Tuition Payers:
Coverdell Education Savings Accounts

There are not many good solutions for parents facing massive tuition bills for a Jewish Day School Education, but there is a little talked about method of saving for tuition that can provide a small amount of relief. This plan is called the Coverdell Education Savings Account, formerly known as an Education IRA.

The Coverdell Account has been basically replaced by far more beneficial and far more well known 529 College Savings Plan. In fact, when my husband and I went to establish Coverdell Accounts for all our children, the financial planner told us he has not opened one of these accounts in many years, and was naturally curious why we were requesting opening this type of account.

While the 529 Plan can only be used for higher education expenses (tuition and fees as well as required books, supplies, and equipment), the Coverdell Savings Account can be used for qualified expenses at private elementary and secondary schools as well as for qualified expenses at institutions of higher education. Both the Coverdell Plan and the 529 Plan allow account holders to enjoy tax exempt earnings, so long as those earnings are to pay for qualified educational expenses.

A named minor can receive up to a total of $2000 a year in contributions from one or more custodians until said minor turns 18. Any individual, related or unrelated, can contribute to this total so long as their Modified Adjusted Gross Income falls below the income limits: $110,000 if single and $220,000 if married filing jointly. Organizations, such as trusts or corporations, may also contribute and are not limited by income.

While $2000 plus earnings isn't a ton of money, the tax free earnings should make a small dent in massive future tuition bills. And while one might wish for a greater contribution limit, $2000 per student is an attainable goal and possibly even a sustainable goal. Given that one must earn approximately $2 for every $1 they intend to spend, the benefit could be more substantial that it appears.

I believe that the frum parent (grandparent, aunt and uncle, or any other qualified person looking to contribute to some one's yeshiva education) would be wise to consider investing in a Coverdell Account for each designated child as the advantages far outweigh any disadvantages.

The major disadvantage is that the assets in the account(s) are considered to be the beneficiary's (i.e. the frum student) for purposes of College Financial Aid. Given the limited amounts that maybe invested in any given year into a Coverdell Account (see below), I can almost guarantee you that the money will be long gone by the time little Chana or Moshe even gets to the point of filling out a FAFSA (Free Application for Federal Student Aid). If, for some reason, the funds have not been used up, the beneficiary can be changed at any time to another person in the beneficiary's family, which should effectively remove them from the student's assets for purposes of financial aid.

The other potential disadvantage is that funds still in the account(s) when the beneficiary reaches 30 years old become his/her property and are subject to taxes and a penalty. But this disadvantage can easily be avoided by rolling the funds over into the name of another family member under 30. With G-d's help, the current beneficiary will be worrying about how to pay for their own children's education and perceived disadvantage (should one be lucky enough to encounter such) will be turned into an advantage.

If you forsee a Yeshiva bill in your future, give this savings plan some consideration.

More information is available via IRS Publication 970: Tax Benefits for Education. The regulations are a bit more complicated that my presentation, but I believe that I have covered the most important points for the reader.


Anonymous said...

WOW thanks! NO plans on saving for college for the twins.... I figure if we still at age 33 have $200,000 in debt and $60,000 + of it is student loans, by the time we have kids in college we would have JUST paid off OUR student loans! *lol*... so I figure they'll take out student loans too (and make smarter school choices than we did! I think inexpensive community colleges are a smart move in retrospect!).

We're not saving for college, but we're going to HAVE to pony up dough for elementary school tuition somehow..... any thoughts on whether it's smart to start this while in debt? Because if not, we'll need to start it when we're 90 and I'm thinking the kids will no longer need it then... :)

Maybe a post on which savings plans (emergency fund only? IRA too? saving for school too?) to begin while in debt and which ones to wait on.....? You take post requests, right?

Ariella's blog said...

While my husband gets apprehensive about locking up money in restricted accounts, the Coverdell can be tapped for yeshiva tuition if the money will be needed before the children enter college.
So we have one for each. Thank you for posting the info about it, including limits.

Orthonomics said...

Twins Mommy-Request granted. I'll get to work. :)

Ariella-You husband is not alone in being apprehensive. But when it comes to Yeshiva Education, we all know we will need to pay for it at some point or another. So I would say that this is a worthwhile savings plan. With 2 income families stretched to the max, there aren't many more options to earn another buck and this extra buck is tax exempt if use properly.

We have Coverdells and 529 Plans. But I'm kicking myself because we have missed 4 years of potential earnings.

I see no way that a family could "overfund" a Coverdell given the steep price of each year of Yeshiva Education. If by chance they do, the balance can be rolled and the benefits will continue to accrue for another generation. I'd call that L'Dor V'Dor.

We only minimally fund the College Savings Plans since saving for Retirement (aka the expenses of advanced age) is a higher priority.

There so many options for higher education. One can start in junior college. One can seek our grants or scholarships. One can work part time during the year. One can take8 years to finish a 4 year degree, but one cannot take 26 years to get from Kindergarten to 12th grade.

Anonymous said...


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Chaim B. said...

>>>Ariella-You husband is not alone in being apprehensive.

It's Ariella's husband here to add my own 2 cents. The upside is great, similar to a ROTH IRA. But if G-d forbid you ever need cash to cover an emergency, a traditional mutual fund is easier to liquidate and can be used to anything you want/need without penalties while these cannot. For example, a family could be sinking $ into a 529 and then have their car unexpectedly go - had the same $ been in a traditional mutual fund they could use it to finance the car, while now they may be stuck with higher loan payments that more than offset the tax savings. Like with everything else, a balanced approach is needed.

Orthonomics said...

Chaim B.

I agree with you about taking a balanced approach. I would not recommend putting money in a Coverdell or a 529 until you have an emergency fund.

My order of priorities is at this previous post, Priorities in Saving:

I really need to reorganize my blog and create more assessable and better labels.

I recommend saving and maintaining an emergency fund first and foremost. One must be able to roll with life's punches or they will find themselves in debt.

For those are fortunate enough to have put together an emergency fund, taken advantage of retirement matching through their employer, and got themselves in a home should they desire, might be interested in 529 Plans and Coverdell Plans.

I would NOT invest in a Coverdell if you are in debt (like my first poster :). I would NOT invest in a Doverdell if you don't have something put aside for retirement.

But, paying something for Yeshiva is practically a given. So, I don't see this being anything but a sound investment for many.

And I think that Grandparents who are stuck with the bill should seriously consider this if they fall in the income limits. I don't know about your locale. But where I live it is "minhag hamakom" for the grandparents to help with this expense. Of course, if it takes grandparents and parents combined to meet the bills. . . . one has to wonder where our grandchildren will be in school.

Scraps said...

I think my parents had such accounts for my sister and me. I seem to recall overhearing conversations about how they were paying for various things, and this rings a bell...

Anonymous said...

well my parents disowned me years ago and didn't even attend my wedding, though they're "stalking" me now to find out info they can use against me..... but the upshot is we're not getting money from them.

Hubby's parents are fabulous people whom we love dearly, but we (sadly) make more money than they do and they're in debt up to their eyeballs too. So it's certainly not going to be minhag hamakom for us to get grandparental help with tuition expenses. OR any expenses.

If things don't change drastically in the next few years (less debt, higher income, or a major tuition break), I will be talking my hubby into letting me homeschool. Should be a very interesting discussion--- his main beef is that how would it look to have a TEACHER having his wife homeschool their children. If the schools aren't good enough for the teachers..... (not that they're not good enough, they're just too dang expensive!).

I would love an emergency fund, but I feel guilty putting even $100 anywhere but towards a credit card. But then I turn around and have to pay for groceries with the credit card, so what's the point? So I WOULD love to hear your take on where to put your money while in debt--- all towards debt, or building towards a small emergency fund and some retirement savings? (We're 33 already, ack!)

Anonymous said...

thanx 4 the info

Juggling Frogs said...

This is excellent information. Thank you!

Anonymous said...

I highly HIGHLY recommend you all buy the book "Total Money Makeover" by Dave Ramsey, and perhaps listen to his radio show (also available only at daveramsey.com). He teaches people how to "act your wage", get out of debt, and save. What I like is that he stresses changing your lifestyle over quick GETOUTTADOUBTNOW schemes, and he is a religious man, and actually refers to his program as Financial Peace University. While he runs many workshops through churches, it's all practical advice that doesn't matter what religion you are. He even includes a 10% tithe in a budget even if you are in debt. I hear him counsel people making $20,000/year, and people making $400,000/year. I think the economics of the frum community would amaze him, however.

My recommendation for funding a coverdell is to follow the government's example with income tax. How do they hide that you pay 1/3 of your salary in income tax? They take it out of your paycheck before you even see it. If you had to write a check for $20,000 to the government every year, you'd freak about how high taxes are and stop voting for people who promise to raise them higher. By making you never see it, they get their money. Use their example. Setup automatic payroll deductions for Coverdells. It will never be part of your take-home pay and will go directly bi-weekly to the coverdells. Trust me--you can adjust your budget (you do have a budget, right?) to live without that money, and it will magically grow without you doing anything.

Same goes for the 401k. I know too many frum people not using a 401k because "we just can't make ends meet and need all the money we can get". They are often leaving money on the table (employer matches), and will just waste the money anyways (trust me, you ARE wasting money, especially if you lease a car). If you set it up, the money will automatically go into the account and you will learn to live without it.

But I can't stress enough, get on Dave Ramsey's plan.