Last week I talked about the basics behind a Coverdell Education Savings Account (CESA). This week I want to explore a strategy for maximizing it’s potential.
One of the fastest ways to grow a Coverdell account that I have found is through the use of wholesaling properties. As a real estate broker, this isn’t my primary business, nor is it even a major focus in my business, but I have two children in high school with major aspirations of college. Think $$$.
Just learning about Coverdell Education Savings Accounts (CESA) this year and an oldest that is 17 years old, I determined that I needed to get a boost! Keep in mind from the previous article in the Coverdell ESA Investment Series, there are limits to your investments into a CESA. You must deliver all of your cash contributions into the account by the time the student reaches the age of 18*.
Another important reminder is the limit of $2000 after-tax proceeds that can be invested into a CESA annually. Fear not, we are going to talk about how to build that $2000 into a meaningful amount of cash for your student.
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Here Was My Strategy:
- I opened a CESA account at one of many custodial account service holders. This is the likely the same list of custodians for self-directed IRAs.
- Established a limited amount of funds (limited to $2000)
- Located some properties in my local market area that needed to sell, but were off-market—Wholesale deals
- I put a $100 earnest deposit from the CESA onto each of the properties.
- I then found a wholesale buyer for these properties using my existing network of buyers.
- I did a double close on these transactions, yielding a nominal $1500-$2500 profit on each transaction.
Translation: I took a $100 investment and turned it into a profit of well over $1000 in a matter of days. This transaction, managed entirely in the name of the CESA, with NO profits to myself, including no commission fees (this is a no-no under the prohibited transactions rule to be discussed in detail later). These profits went into the CESA account completely tax free. My student will be able to withdraw those funds for qualifying education expenses without paying tax. What can be better than that?!?!
This is probably the most basic way that one can build a substantial CESA balance in a short period of time. There are other nominal investment strategies that we will cover later in the series.
If you have an account that has some value, maybe from a rollover account into a CESA, your options can open up significantly. Consider a private money investment, or a full down payment and rehab on a fix and flip. Remember on these that you must use a non-recourse mortgage, as your CESA cannot accept a liability risk. If you have time, buy notes and collect longer term income.
CESA is an education IRA for a lack of a better analogy. It is benefited over a 529 for several reasons. One, it can be used on qualifying education expenses from Kindergarten through college and Secondly, it can be self-directed rather than a states (modest) investment plan. Cash investments must be made by the time that the student reaches the age of 18, but can be spent up until the age of 30. At the age of 30, the account must be spent, rolled over to another qualifying student or cashed out at a penalty. Income invested into a CESA is after-tax. The qualifying distributions are made tax free, hopefully after substantial investment growth. See the orignal article for more basic information.
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 an accountant, nor do I want to be an accountant…anymore. You are advised to seek the advice of an accountant, financial advisor, and/or an attorney before making investment decisions. The advice presented in this column is from my own research, deemed to be reliable sources, but not guaranteed.
Photo Credit: Gates Foundation