THE USES AND BENEFITS OF 529 AND COVERDELL PLANS

From the moment a new child is welcomed into a family to the time they embark on their own, questions related to the optimal savings strategies for them frequently arise. These questions can range from depositing monetary gifts from grandparents into savings accounts, to introducing children to financial markets through investment accounts – the options can be dizzying.

The most urgent question, likely due to the hefty price tag, is the funding of higher education. Although liquid savings maintained in bank accounts or in minor’s investment accounts, including Roth IRA’s and non-retirement accounts, generally offer more lenient contribution and ownership rules compared to college savings plans, they may lack the tax benefits of the latter.

So, what are your options when saving for private school or college in a tax advantaged way? 

Introduced in 1997, Coverdell education savings accounts were the initial option for tax-free savings aimed at educational expenses, extending from Kindergarten through secondary education. These accounts permit diverse investment choices across stocks, bonds, mutual funds, and exchange traded funds. The primary limitation, however, is the $2,000 annual cap on contributions. Even with savings starting the day the child’s social security number was issued, the total accumulation by their 18th birthday would only be $36,000, plus any returns. 

For families looking to save beyond that threshold, 529 plans offer a worthwhile alternative. Instead of an annual limit, 529 plans have a state specified lifetime maximum (e.g., $550,000 in Connecticut, $520,000 in New York) per beneficiary. Additionally, Connecticut and New York provide annual state tax deductions up to $5,000 for individual filers and $10,000 for joint filers, contingent on participation in the respective state’s plan.

The primary application of a 529 plan is to finance a child or grandchild’s future college expenses with the advantage of tax-free disbursements for qualified education expenses. Distributions can be used towards accredited post-secondary and trade institutions, both domestically and internationally, and also permit up to $10,000 annually for private primary education tuition. Some families fund a 529 plan with the intent of eventually transferring the account to the child as an adult, thereby extending the tax-free growth period for the benefit of future generations. 

Certain states offer pre-paid tuition plans under the 529 framework, allowing for savings for tuition at state-affiliated schools and often securing current rates. These can be paid as a lump sum or via installments and typically involve the purchase of units, credits, or years of education –  though they will typically not cover room, board or transportation costs. Notably, New York and Connecticut do not offer these types of plans.

The 529A Able Plan, launched in 2015, offers a special savings strategy for families with special needs dependents. Traditional trusts, while useful, impose certain complexities to families with special needs children. In contrast, the 529A Able plan supports tax-free savings for a range of essential services – education, housing, job training, health and legal affairs – without jeopardizing eligibility for federal benefits like Social Security or Medicaid, provided the account balance does not exceed $100,000.

 

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