Whatever happened to the poor little Coverdell education savings account?
It's become the orphan of college savings plans--ignored, neglected, unable to get adopted by many financial consultants even though it lets people shield their college savings from taxes.
Instead, 529 college savings plans, which also keep the tax man away from college savings, have taken center stage in the financial services industry. They roll out of financial plans designed for parents and for grandparents interested in lightening up the value of their estates. They are touted in advertising campaigns and covered incessantly by the personal finance media.
If you simply paid attention to advertising blitzes, you easily would get the idea that 529s are the only way to save for college. You might figure that there is something wrong with Coverdell accounts.
But that's not the case.
Coverdell accounts, which let people invest a maximum of $2,000 a year per child, simply aren't lucrative enough to the financial services industries to generate enthusiasm. So they lack advocates and aren't the stuff of advertising campaigns. State governments don't promote Coverdells to small savers either, because states operate 529 plans themselves and want to attract all the assets they can into them, said Kaye Thomas, a Chicago tax attorney and editor of Fairmark.com.
Since their introduction in the 1990s, Coverdells have taken a bit of shunning. Many states give residents tax breaks or matching funds for stashing money in 529 plans, but they don't give any incentives for dropping a little cash into a Coverdell account.
Recently, when Congress passed a measure that will let parents remove savings from 529 plans free of taxes after 2010, in addition to getting Hope and Lifetime tax credits, lawmakers neglected to give Coverdell account investors the same benefits.
After 2010, unless Coverdell accounts can get Congress' attention, people using money from them for college won't be able to claim the tax credits too.
"Coverdells aren't promoted because the $2,000 limit on contributions doesn't excite investment firms," said Joseph Hurley, a certified public accountant and college funding expert who publishes SavingforCollege.com.
In contrast, financial advisers are excited about 529s because parents and grandparents can invest up to $120,000 in them in a single year. They have become a popular way for people to move money out of accounts that can be taxed and into accounts that are off limits to the IRS and state taxes, Thomas said.
Although shielding large sums from taxes is a reason for wealthy people to prefer a 529 plan, anyone saving $2,000 a year might find a Coverdell account more attractive, said Rick Darvis, a certified public account and college-funding expert based in Plentywood, Mont.
Moderate-income people often cannot save the entire cost of college and need financial aid grants from colleges. Financial-aid approaches differ among colleges, but Darvis said at some colleges Coverdell accounts can be less likely than 529 plans to interfere significantly with financial aid grants.
In addition, he said, investors have more flexibility when they use a Coverdell account rather than a 529. The 529 plans are administered by states and provide people with only a handful of investment choices. Sometimes the mutual funds within 529 plans become disappointing.
Yet legal constraints on 529 plans keep investors from shifting money more than once a year. In addition, fees can be high, eroding a parent's ability to generate a college fund as large as they might in a well-managed Coverdell account, Darvis said.
Joel Dickson, a principal at the Vanguard Group, also likes the flexibility of a Coverdell account. But for parents trying to save large amounts of money for college, there doesn't have to be a choice between a 529 and Coverdell.
Dickson said he is using both accounts. The 529 plan gives him a state tax deduction, an incentive for using a savings plan offered by the state. And the Coverdell account gives him the flexibility to choose any investment he wants and to change investments at will.
Contact Gail MarksJarvis at email@example.com or leave a message at 312-222-4264.