Sunday, January 29, 2017

Education, education, education

No, this post is not about benefits of education. Let's figure out how we can help ourselves paying for it. 

What do you know about deducting the costs of a summer school class your child is going into this summer? Or how about deducting the registration costs for a middle school?

I am sure you all heard about 529 plans. Some of you are very good at it and you are already contributing to one, others are thinking you still have time. Regardless, whatever you are saving into 529 plan or not (shame on you and me, btw), 529 plans cannot be used to pay for your high school or middle school expenses. 529 plans are meant ONLY for higher education - college, university, post-degrees...

Educational IRA - You may have heard that name somewhere. But, not many know what it is or what it does. 

First of all, it's not even called Educational IRA, not since 2012. It has a new name - Coverdell Education Saving Account - fancy name, but it is an IRA, nevertheless. 

It is not a traditional IRA, and you cannot deduct it off your income tax, but it is a very powerful tool to help pay for some of those ever-increasing educational expenses. So, let's get our hands dirty and learn about it and how it can help you save.

Coverdell contribution is limited to $2K per year. So, if you want to maximize the potential, you need to start contributing early. Whoever opens an account becomes its "owner", a custodian - I will explain why it matters a little later. You assign a Coverdell plan to a specific beneficiary, your child. It's okay if you have more than one, just go for the oldest first, trust me.

You can contribute to a specific child's plan until he/she turns 18. From that point on, no more contributions are allowed. And all funds must be distributed or re-assigned when your child turns 30 (no restrictions apply if your child has disabilities).

What can you deduct?
- Any school required tuition and fees; room and board; books, supplies and equipment; 

What can you not deduct?
- Medical coverage or insurance, even if a school requires it; transportation costs; most of the electronic/computer equipment, with some exceptions.

What schools qualify?
- Any public (kindergarten thru K12 grades), private or religious schools, and higher education schools already covered under 529 plans. And, yes, you can have both 529 and Coverdell plans at the same time.

Everyone thinks that these plans are hurting your chances for financial aids, and they do. As long as you are the custodian of these accounts, slightly over 5% of your assets are counted against you in determination for a financial aid, same as 529 plans. But, here is where the Coverdell plan is flexible. You can re-assign the "ownership" to someone else, your relative or even your friend. You can even re-assign it to your company if you have one. Or better yet, set it so your company contributes to Coverdell plan directly.

You can open Coverdell plan at most major brokerages and even banks. You can invest in stocks, mutual funds, money market, etc. You can't invest in annuities, but it makes no sense to do it anyway.
And you can move your plan from one provider to another anytime you want, like an IRA. Something, you can't do with 529 plans.

All your original contributions can be withdrawn anytime, no taxes to pay, no fees and no penalties. Any profit you make is tax free as long as it is used to pay for the qualified educational expenses.
You can also change a beneficiary, like 529 plans do. Just once-a-year. Nothing is perfect. But, this plan is almost is. 

One biggest caveat of the plan, in my opinion, is that you need to pay yourself back for the expenses in a year you incurred them. So, if you are paying for that summer school this year, pay yourself before the year ends. Why is it so bad? Because if you are starting late, as I am, you have not accumulated much of the gains and compounded interest to make enough profit on the account so it pays for itself.

I have not covered all small fine print details, you might have different circumstances, so it is always a good idea to discuss it with someone knowledgeable about it. If you like reading boring IRS publications, like me, here is a reference for you:

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