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Coverdell College Savings

Chris Farrell Apr 29, 2008

Question: I have 2 Coverdell IRA’s for my 2 children, to which I contribute what I can. I’ve heard that the program is set to expire in 2010. 1) Is this true? 2) Does this mean I have to get the money out and close these accounts before 2010? My children are both under 10 years old. Brian, Ann Arbor, MI

Answer: You’re right that a number of the college savings attractions attached to the Coverdell will end in 2010. I’m not really sure why Congress improved the 529 college savings plan in 2006 but left the Coverdell vulnerable. But it did. For instance, the Pension Protection Act of 2006 made withdrawals from 529s permanently tax free when the money goes toward qualified educational expenses, like tuition. What’s more, the sums invested in 529 plans aren’t considered a student asset in the financial aid formula calculation.

In sharp contrast, the Coverdell didn’t get legislative protection. No, upgrade passed in 2001, such as raising the contribution limit from $500 to $2,000 and allowing tax-free withdrawals for K-12 expenses, are still slated to expire in 2010. The Coverdell will be then much less attractive choice for college savings. For instance, right now you can make tax-free withdrawals from a Coverdell to pay for college and still take advantage of the Hope or the Lifetime Learning credit. After 2010, you’ll be forced to decide which benefit to take, the tax free withdrawal or the credit.

What to do? If you like your Coverdell accounts you can continue to make contributions into them. If the Coverdell bells-and-whistles do expire, you can always roll the money over into a 529. (It’s a tax-free rollover.) You can gamble that Congress will get rid of the 2010 sunset date. Or you can open up a 529 plan for your children. No matter which choice you make, your savings will compound tax-deferred and your children will benefit from your thrift. I just wish Congress would stop all this nonsense about sunset provisions. It makes savings more complicated than it should be.

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