Have you checked out the sticker price of a college education lately? You might want to sit down first (a box of tissues is also advised). According to 2012-2013 numbers from the U.S. Department of Education, the average price for a single year at a private four-year college (tuition, fees, room and board) was around $35,000 [source: NCES].
But what if your little ones won't be entering college until 2021? Is the cost of college expected to go down, or at least — please — slow down? Hold on to that tissue box, pal. A private four-year college is projected to cost around $50,000 for tuition, fees, room and board per year [source: Ally]. That's actually not so hard to believe, as some Ivy League schools already charge more than that in 2014.
The good news is that the federal government recognizes the critical importance of education and has established a number of college savings plans with built-in tax benefits. One of those plans, established by the Taxpayer Relief Act of 1997, is called the Coverdell Education Savings Account (ESA).
Coverdell ESAs share a lot in common with 529 college savings accounts offered by individual states. The most important similarity between Coverdell ESAs and 529 plans is that they are both double tax-free. Money in these education investment accounts grows tax-free and all payments from the accounts are distributed tax-free as long as the money is used for a qualified educational expense. Contributions to both types of accounts, however, are not tax-deductible.
There are some important differences between Coverdell ESAs and 529 plans, though, including the following [source: Saving for College]:
- Coverdell ESAs have an annual contribution limit of $2,000 for each beneficiary; 529s have much higher limits — over $300,000 in many cases.
- Contributions to a Coverdell ESA phase out if you make more than $95,000 ($190,000 for joint filers); 529s have no income restrictions.
- Money in a Coverdell ESA can be used to pay for both college and certain K-12 expenses. 529 funds can only be used for college.
- Coverdell ESAs offer more control over investment options, while 529 plans are managed funds.
- Remaining funds in a Coverdell ESA are distributed to the beneficiary at age 30, while 529 plans typically don't have any age restrictions.
To claim the full tax benefits of a Coverdell ESA, you need to open an account with an IRS-approved bank or financial institution. In turn, that bank or trust company must file a report with the IRS every tax year detailing how much money has been contributed to the account. That report is called the Form 5498-ESA. Keep reading to learn how to read the 5498-ESA and how to make sense of the IRS fine print.