Coverdells not as flexible as 529 plans

05/18/2009

QUESTION:
Dear Joe,

How many different Coverdells can be set up in how many different banks by how many different people for the same child?

--Jim

ANSWER:
Dear Jim,

There is no limit on the number of Coverdell education savings accounts one child can have. There is also no limit on how many different people can establish a Coverdell account. Anyone with a modified adjusted gross income below $95,000, or $190,000 for joint filers, can make a contribution. Reduced contributions are permitted for those with $95,000 to $110,000 in modified adjusted gross income, or $190,000 to $220,000 for joint filers.

The problem is that total contributions to all Coverdell accounts for the same child can't add up to more than $2,000 in any calendar year. Anything more is subject to a 6-percent annual excise tax, payable by the beneficiary. Contributions from individuals whose modified adjusted gross income exceeds the phase-out limits are also labeled excess contributions. The excise tax can be avoided if the excess contributions, along with any earnings attributable to those contributions, are distributed by May 31 of the following year.

As a practical matter, Coverdell accounts should be opened only by the child's own parents. Many banks and other financial institutions offering Coverdells require $2,000 to open the account, effectively preventing multiple accounts. And most Coverdell legal agreements specify that only a parent or legal guardian of the beneficiary can be named as "responsible individual" on the account, even where the contributor is a grandparent or other third party.

The 529 plans offer more flexibility and fewer penalty risks when other family members wish to set up college savings accounts. You don't have to worry about income limits or excess contributions, and the contributor can retain ownership of the 529 account regardless of the child's relationship.

Here is a list of low-cost CESAs.

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