A Basic Strategy To Grow A Massive Education Savings Account Tax Free

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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.

Coverdell Basics:

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

About Author

William Robison

Real Estate professional dedicated to the success of investors through a suite of turnkey services for buy/hold investors and flippers. Experienced real estate flipper. Worked in real estate since 2003. Aiming to work with clients to build long-term investments and take advantage of continuing market improvements.

6 Comments

    • Adrian-
      Thats a great question. Similar to investing with a self-directed IRA, since the owner of the asset is the account and not the person, then the asset (house) can only be protected by the asset itself and not the account.
      For an IRA or a Coverdell ESA, using a self-directed account to use a mortgage (note) to leverage a property, the account itself cannot be liable for a mortgage loss, ie-foreclosure. You cannot foreclose against an account like you can a person.
      Most mortgages written to people, or even an LLC, can have a recourse. This means that it can technically come back after a deficiency. If someone loses a house to foreclosure, the bank/lender can sell the house, if there isnt enough money to cover the loss, they can go after the person for the difference. This is a recourse loan.
      A non-recourse loan means that the lender cannot go back after the borrower (account) if the property becomes foreclosed.
      As I will discuss in future articles on Coverdells, there are a few lenders that specialize in these accounts, and typically at lower LTVs, but you still reap the benefit of the leverage in the long run.
      I hope that helps. Let me know if its not clear.
      All the best with your investing.

  1. I’m not much of a fan of these complex 529 or Coverdell plans. There are too many strings attached. Did you know that you can actually write a check directly to your kids’ college and avoid gift taxes? [1] This means you don’t have to hand your kids any money, you/them pay taxes, and then use the money.

    I’ve decided my best strategy is to pour extra money into my wealth building plan, which includes rental property, dividend paying stocks, and an EIUL. When it comes time for my kids to go to college, I can write a check to the university. This also gives me other options in case my kids don’t go to college and choose another path. What is the way out of a 529 or Coverdell plan in that situation?

    Frankly, I’m not sure what tuition will cost in 18 years. Do you think setting aside $2000/year for 18 years ($36,000) will be enough? What if it’s not? In 18 years, I’ll have a nice portfolio, and could probably either sell a unit to pay for college, refinance, or borrow from my EIUL. Options, my friend, options!

    [1] – http://www.retirementwatch.com/GrandkidsSample4.cfm

    • Greg-
      There are a few questions in your comment:

      First, the “way out” actually has several options. First, the account proceeds can be transferred to another person, another child, a grand-child, a niece, even a friend. Its a very liberal transfer rule.

      Tuition, in 18 years, is likely to be enormous, some would argue that it already is.
      Regarding how much you can save in 18 years, I think you missed part of the benefit. Its not a cash gift that you set aside, its an investment vehicle that can grow substantial returns over the course of many years, beyond 18 years actually, that can pay for tuition without paying taxes on the money spent.

      Yes, you can gift a person a portion of money that they do not pay taxes on. However, that is currently limited to $14000 (2013). The schools that I will have to write a check for will cost much more than that.

      My plan, for just one transaction, is to invest $100 in taxed income into a property, with a several thousand dollar untaxed return. This transaction, in the instance stated in the article took two weeks to put together, and less than 30 minutes to execute. After several of these transactions, I will yield far greater than $14000 annually that no one, myself or the recepient, will pay taxes upon.

      All the best with your investments.

  2. Gordon Cuffe

    great article. I found it doing a google search about cesa. I have belonged to bp for many years and just found this article today. I will be buying houses in the Kansas city area in the name of my son’s cesa to build up his account .

  3. David Morgan

    How does the double close work with regard to the Coverdell ESA? This strategy looks like a great way to build up a Coverdell, IRA, or HSA for that matter. Does your Coverdell account have a trustee that you get funds from, or do you have something with checkbook control?

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