Q. I contribute money to my grandchildren’s Coverdell accounts every year. Can I deduct my deposits from my income tax?
A. You might be disappointed here.
Contributions to Coverdell accounts, also known as Education IRAs, are deemed gifts and so they’re not tax deductible for the giver. They’re not taxable to the beneficiary, either, said Steven Gallo, a certified public accountant with U.S. Financial Services in Fairfield.
“The growth on these contributions is tax-free as long as the funds are used to pay for qualified educational expenses,” Gallo said. “Failure to do so will result in taxes being due on the earnings at ordinary tax rates plus a 10 percent penalty.”
Gallo said for Coverdell accounts, no contributions can be made once the beneficiary turns 18 years old and all funds must be distributed from the account by the time the beneficiary turns 30.
Let’s compare the Coverdell to 529 plans.
Both accounts are tax-advantaged savings plans to be used for qualified educational expenses of a specified beneficiary, Gallo said.
However, he said, contributions made to a 529 plan can only be used for post-secondary school expenses while Coverdell funds may be used for certain elementary and secondary school expenses.
Then there are the contribution limits.
Annual contributions to Coverdell accounts are limited to $2,000 per beneficiary until age 18, while most 529 plans have a lifetime contribution limit of $300,000, Gallo said.
In addition to lifetime limits, some state plans have annual maximum contribution limits, he said.
And, you have to make sure you qualify to contribute to a Coverdell.
If your modified adjusted gross income (MAGI) exceeds certain amounts, you can’t contribute. Phase-outs begin for single tax filers at $95,000 and joint filers at $190,000, Gallo said.
Another major difference in the two plans is the age of the beneficiary.
“In a Coverdell plan, no contributions can be made after the beneficiary reaches age 18 and all funds must be depleted prior to the beneficiary reaching age 30 to avoid tax consequences,” he said. “529 plans, for the most part, have no such age restrictions.”
The tax treatment of both account types are pretty much the same, Gallo said.
“There is no tax deduction for contributions and the returns on the accounts are tax-free at the federal level for both as long as they are used for qualified education expenses,” he said. “State taxation rules will differ depending on local regulations.”
Also, both accounts provide for a federal 10 percent tax penalty on any funds not used for qualified expenses, Gallo said.
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