The Three Cs Of Education Planning

Today, you have many alternatives for planning for your child’s future education. Here are three options: custodial accounts, Coverdell accounts and college savings plans. The other three Cs that you also must keep in mind: college, control and carte blanche.

In the past, Coverdell education savings accounts were known as education IRAs. Coverdell accounts allow nondeductible contributions to be set aside for a named beneficiary. Annual contributions are limited to $2,000 per beneficiary. Earnings are tax-exempt as long as withdrawn funds are used toward qualified education expenses; otherwise, distributions are subject to ordinary income taxes and a 10 percent penalty. Qualified distributions include primary and secondary school expenses in addition to college expenses.

Section 529 College Savings Plans let individuals contribute substantially more money. Assets in 529 plans grow free from federal income tax and can be withdrawn tax-exempt if used for qualified higher-education expenses. The law allowing federal tax-free withdrawals is set to expire on Dec. 31, 2010. Qualified expenses include accredited colleges, universities, vocational and technical schools. However, they do not include primary and secondary schools.

Section 529 plans allow account owners to contribute up to $55,000 ($110,000 for married couples) per beneficiary in one year without incurring gift taxes.

While the investment may be excluded from the contributor’s taxable estate, the contributor still maintains ownership and “control” of the account. Thus, both “college” and “control” are significant in the use of 529 plans.

The last vehicle is the oldest tool. Custodial (UTMA and UGMA) accounts are not tax-deferred, and any income is taxed annually. Upon reaching their majority age, the contributed funds revert to the child. Funds may be used for anything, without restriction, resulting in our third C, or “carte blanche!” Neither college nor control is a requirement of a custodial account. However, custodial accounts can still be useful for gifting, planning and intergenerational wealth-creation purposes.

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