Coverdell Education Savings Account (CESA): The Key To A 40% Savings On Education Expenses
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Want to help them pay for college?
Want to survive those tuition bills?
This post will help you learn about the Coverdell Education Savings Account (CESA). But first, understand that with this type of account, it doesn’t just have to be for college. You could be like a client of mine who is considering a Kindergarten program for their now two year old in NYC, that cost more than her 4 years of college.
A CESA can be used to pay for qualifying expenses for a student from Kindergarten through College. Additionally, the beneficiary (Student) does not have to be your child. You can help fund a grand-child, niece, nephew, even a friend.
So, 40 percent? The typical real estate investor has approximately a 28% tax bracket, and when doing a short term flip, may also be paying a 15% capital gain tax. Using strategies to be discussed, one could ultimately save more than 40% on taxes by using a Coverdell Education Savings Account.
Basic Introduction to a Coverdell Education Savings Account
The Coverdell ESA was originally designed by U.S. Senator Paul Coverdell (R-Ga). The Coverdell account, on the surface, appears to be very similar to the more well-known 529 Plan for education savings. However, a major distinct advantage is the allowance of investments in real estate, as well as many other investment vehicles. There are other advantages to the Coverdell account to be discussed later.
Here are some major highlights of the Coverdell Education Savings Account (CESA):
- Investments into the account are not tax-exempt. These funds are invested post-income tax.
- Investments into the account grow tax free*.
- In the big picture, a CESA is like a self-directed Roth IRA
- Withdraws are made to fund education expenses including tuition, room and board, books, computers, transportation and more. These withdraws are taken tax free*.
- Unlike a 529 Plan, a CESA can be used for education expenses from Kindergarten through College, until the beneficiary turns the age of 30.
- A CESA can invest in stocks and bonds, just like a 529, but it can also invest in other investments such as real estate, private lending, etc. There are a few exceptions of items that cannot be invested into. The 529 is limited to a state-run investment plan.
- With a 529 Plan, investments into the account can be almost limitless, but with a CESA, annual contributions to a beneficiaries’ account are limited to $2000 from all contributors (parents, grand-parents, friends, etc). This may sound detrimental, but consider some of the investment options.
- CESA accounts do not permit self-dealing, meaning that you cannot co-mingle funds with the account on an investment, and you cannot benefit from the invested asset. No staying in the vacation condo that the CESA account owns!
- There are income restrictions for the contributor to be discussed later.
- CESA assets are transferable to a wide range of other potential benefactors.
- Contributions into a CESA account must stop when the beneficiary reaches the age of 18*.
- There are several forms of prohibited transactions to learn through the process.
Over the course of the next several weeks, I plan to write a series of Coverdell Education Savings Account articles for the BiggerPockets community. In doing so, my goal is to become the expert on the subject, especially as it relates to real estate investing. There are other important factors to learn about CESA’s, some will be enlightening, others, well, they will just be plain boring, like reading tax code, but they are important for anyone interested in using the CESA to fund someone’s education without paying tax.
Topics to be covered over the next several weeks could include:
- A basic strategy to grow a massive education savings account tax free*
- Fix and Flip without paying capital gains taxes by benefiting a student
- Funding mortgage and private investing notes to grow a Coverdell ESA
- Prohibited Real Estate Transactions for a Coverdell ESA
- Who can benefit from and who can contribute to a Coverdell ESA (including who controls and why)
- Additional Limits and Necessary Exclusions of a Coverdell ESA
As a wrap to the series, I plan to have a Coverdell ESA Q&A (put your questions into the comments)
You can find the basics of the tax code at the IRS website, Publication 70, Chapter 7, regarding Coverdell ESA’s.
Disclaimer: I’m not a financial adviser or an accountant, nor do I want to be…anymore. You are advised to seek the advice of an accountant, financial adviser, and/or an attorney before making investment decisions. The advice presented in this series of articles regarding Coverdell Education Savings Accounts are culminated from my own research, deemed to be reliable sources, but not guaranteed.
Photo Credit: Bindaas Madhavi