Coverdell Rules Are Changing

As a way to save for college, Coverdell Education Savings Accounts have taken a back seat to the far more popular 529 college-savings plans. Upcoming changes in the rules governing Coverdells are likely to make them even less attractive, as they will limit both the amount you can contribute as well as the kinds of expenses for which you can make tax-free withdrawals.

When Coverdell accounts were first introduced, the maximum yearly contribution was set at $2,000. Starting in 2011, the contribution limit will go down to $500 a year. In comparison, the yearly contributions on 529 plans are essentially unlimited, although the gift tax does come into play because they are considered gifts.

For married couples filing jointly any, putting any amount over $26,000 into a 529 plan will trigger the gift tax. For singles, the gift tax applies to any amount over $13,000. High-income earners may not be eligible to make Coverdell contributions at all; 529 plans have no such restrictions.

One advantage that Coverdell accounts have over 529 plans is that you can take tax-free money from a Coverdell to pay pre-college expenses from kindergarten through 12th grade, including private-school tuition, books, and computers. That benefit will likely disappear next year. Although Congress could act to extend it, Washington watchers see that prospect as iffy. If you need to tap Coverdell funds for K-12 expenses, tax consultants suggest you do it this year.

Coverdell accounts, on the other hand, do offer a wider range of choices, which means you can put your money into whatever investment vehicle you want to. With a 529 plan, you are limited to the menu of options offered by the plan administrator. For tips on putting away money for college, go to Savingforcollege.com.