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COLLEGE SAVINGS 101

Coverdell accounts to lose K-12 feature

03/17/2010

QUESTION:
Dear Joe,

I am having the hardest time finding a bank that has a Coverdell savings account that is not a certificate of deposit. I want just a savings account that I can put in up to $2,000. I have tried locally and online. Can you point me to a few institutions?

Please do not point me to 529 plans; I want a Coverdell account for personal reasons. We are older parents, and if we die, I want our relatives to use the Coverdell money for private schooling. ... It is not a lot, but it will help.

-- AJ

ANSWER:
Dear AJ,

I can't help but point you to 529 plans. You may not realize this, but a Coverdell education savings account, or ESA, cannot be used for K-12 expenses after this year. Beginning in 2011, withdrawn earnings are taxable and subject to a federal tax penalty unless they are used for eligible post-secondary expenses, such as college costs, just like a 529 plan.

Of course, Congress and the president could agree to extend the K-12 provision for ESAs beyond 2010. But I have my doubts they will, mostly due to politics.

The reason I would point to 529 plans for your needs is that I have not come across any financial institutions offering a savings account as an investment option in an ESA. That doesn't mean there aren't any, but you will have to keep searching to find one. For example, you could try your local credit union. Also, be aware that many ESA providers have high account minimums of $1,000 to $2,000.

However, you can find FDIC-insured savings accounts in a small number of 529 plans, and these plans generally have low minimum contributions. Here are some examples:

-The Utah Educational Savings Plan offers a savings account through Zions First National Bank.
-Colorado's CollegeInvest Smart Choice College Savings Plan has a money market savings option through FirstBank.
-Ohio's CollegeAdvantage offers a savings account through Fifth Third Bank.
-Virginia's CollegeWealth has savings account options at both Union Bank & Trust and BB&T.

There are a number of other options in various 529 plans that offer the same degree of liquidity as a bank savings account and seek to protect your principal from loss, albeit without an FDIC guarantee. These include money market funds, stable-value options and guaranteed options. To locate them, use the 529 comparison tool at Savingforcollege.com.

If you decide to repurpose your savings for college use rather than for K-12 expenses, you may be more interested in the investment options designed to provide a higher return such as certificates of deposit and mutual funds. Whether you wish to use an ESA or a 529 plan, you will find many such options available to you. Along with all the 529 plans, a list of low-cost ESAs is maintained at Savingforcollege.com.

If K-12 remains your target and you wish to stick with a bank savings account, you could simply open it under the Uniform Transfers to Minor Act, or UTMA. Although such an account is taxable, the interest income falls to the child's tax return where it can be fully sheltered by the dependent's $950 standard deduction. Best of all, UTMAs are easy to open and do not require that they be spent for any particular purpose.

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