Coverdell Education Savings Accounts or ESAs

A Coverdell ESA, previously known as the Education IRA, is a trust or custodial account set up to pay for the education expenses of a child. With an ESA any individual can contribute up to $2,000 a year. Just like with an IRA, you have more say in where the money is invested, whether its stocks, bonds or mutual funds. The money grows tax-free, as long as it is used for education.

One benefit of Coverdell ESAs is that you can use those savings to cover the cost of attending elementary and secondary schools, whether it’s a uniform or laptop computer. You are in control of the account until your child turns 18.

Like any other investment account, you can open a Coverdell ESA at a bank, brokerage firm or mutual fund company, which means there could be fees associated with it.  If you are single and make more than $110,000 or married and make more than $220,000, you can’t participate in an ESA.  If the money isn’t used by the time the beneficiary reaches 30, it has to either be distributed within 30 days or rolled over to another family member. If it is distributed it will be taxable and subject to an additional 10% tax.

Uniform Gifts to Minors and Uniform Transfers to Minors Acts or UGMA/UTMA Accounts

Just like the Coverdell ESA, the UGMA and UTMAs are accounts you set up for your child that allow you to invest in mutual funds, stock and bonds.  But unlike the ESA, once you’re child turns 18 or 21, depending on the state, he or she take control of the money and can use it in any way they see fit. Also, the money has to be spent on the child the account was set up for and can’t be transferred to another family member.

One of the advantages of these accounts is potentially more favorable tax rates. Since the account is technically owned by the child, it is taxed at the child’s rate, which is usually lower.  If the child is under 19 or 24 and is a full time student, up to $950 in the account is tax free while the next $950 is taxed at the child’s tax rate. Anything over $1,900 is taxed at the parent’s rate, according to mutual fund company T.Rowe Price.

Keep in mind that since the account is considered the child’s asset, it could impact the amount of financial aid the child can get.

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