Educational Funding Programs Part 2
Coverdell ESA’s, previously known as Education IRA’s, are another way to prepare for a child’s education. They are a way to make smaller contributions over time to children under the age of 18. Here are some attributes specific to Coverdell ESA’s:
- Contribution limit of $2,000 per year, per child and these contributions must cease on their 18th Contributions to the account can be made by anyone.
- The $2,000 contribution limit begins to decrease when contributors earn a certain income. For single people earning over $95,000, a partial phase-out begins and earners over $110,000 are not allowed to contribute to the account. These numbers double for joint filers.
- Contributions are not tax deductible; however, all earnings are tax deferred and if the funds are used before the age of 30 for qualified education expenses, they can be withdrawn tax free.
- Withdrawals for non-education expenses are taxable and subject to a 10% penalty.
- If the account is not used by the age of 30, the funds must be distributed, taxed, and penalized or the account can be rolled over into a different Coverdell ESA for a family member.
In addition to Coverdell ESA’s, there are several bond strategies that can be taken to help fund a college education. Bulleting, laddering, and purchasing zero-coupon bonds can each be beneficial. Let’s look at how these strategies work:
- Bulleting – Bullets are meant to hit a target, and in this example our target is funding a child’s education. In this strategy, bonds are bought at different times but have the same maturity. For example, if the child is six years old, bonds can be purchased now with 12-year maturities, then in two years buy bonds with 10-year maturities, and when they’re 12 years old buy bonds maturing in six years, and so on, having them all mature when it’s time for them to go to college. The bulleting strategy allows the investor to capture different interest rates to help reduce the possible missed opportunities of being locked into one rate.
- Laddering – This approach is virtually opposite the bulleting strategy and both can be equally useful depending on when payments are going to be made. In this strategy, bonds are bought at the same time but they each have different maturities. Say the child is expected to go to college in five years, you can purchase four bonds, maturing in 5, 6, 7 and 8 years and this will give some help each year the child goes to school.
- Zero-Coupon Bonds – Another useful tool for hitting a target is a zero-coupon bond. True to its name, these bonds pay no interest, instead they are issued at a large discount from par. For example, if you have an eight-year-old child expected to go to college in 10 years, you can purchase several zero-coupon bonds with 10 year maturities. The bonds may be issued at $500, will pay nothing for those 10 years, but when it’s due the investor will receive the $1,000 par. These bonds can be more volatile than others, but they can be a great tool for preparing for a target goal with a specific date.