The Best-kept Secret: 529 Education Savings Plans – A little-known fact that can transform your Coverdell ESA into a college savings powerhouse is the fact that you can direct the investments yourself.
A Coverdell ESA is much better than a 529 and the best tool to save and build wealth for tax-free college expenses. The problem is that the Wall Street lobby makes it easy to contribute and operate a 529. This has to change! In the meantime, know that Coverdell uses a secret weapon that can build a college nest egg faster than a 529. Investment accounts are key to your future, including a 401K. KKOS currently has a $100 401K setup special, click here to check it out.
The Best-kept Secret: 529 Education Savings Plans
I realize that my bold opinion may conflict with what you have heard from your tax professional or financial advisor. I’ll clarify this opinion and explain why Coverdell is a “hidden gem” in the financial market for college savings.
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The bill is named after its primary champion in the US Senate, Sen. Paul Coverdell, Republican of Georgia. The name “Coverdell ESA” can be confusing, as this tax-advantaged structure has been called by different names in the past. Since it was originally adopted in 1997, it was called the Education Savings Account, the Coverdell Account, and formerly known as the Education IRA. IGNORING ALL OTHER NAMES… they are all combined into one: the Coverdell ESA, which I will call simply “Coverdell” in this article.
Basically, the answer to why 529s get so much more “press” and special treatment is two words: Wall Street. The financial industry can act and bury their deceptively expensive fees in 529 accounts. Which is almost impossible to identify and calculate.
To encourage Wall Street investment in 529 accounts, they lobbied Congress to make them more attractive:
Plus, they’re awesome! The reason is that you have no control over your investments and you don’t know what fees you are paying. That way, you let the financial industry play with your money unchecked, which they love.
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If you don’t like what I say on Wall Street, just let the 529 account stand alone… I didn’t mean it that way. We will continue to try to lobby Congress for what is fair and allow investors to choose their own investments.
A little-known fact that can transform your Coverdell into a college savings powerhouse is the fact that you can direct the investments yourself. You can invest in what you KNOW BEST…not the options spoon fed to you by Wall Street and 529 sponsors. Proponents of the 529 Plan rarely acknowledge this, let alone mention it.
This is significant, if not life-changing, as the average 529 ROR (rate of return) is well below 10% (annualized after expenses – which really matters). Coverdell returns can be unlimited, with lower costs and much more control.
Example #1: Yes… Cryptocurrencies have been down since last year. However, if you had invested your $2,000 Coverdell on May 1, 2020 in Ripple-KSRP cryptocurrency, about a year later on April 29, 2021, it would have been worth $180,797 (9.039% rate of return)! Are you kidding me?! Yes, cryptocurrency is clearly a risky investment and that is not the value of KSRP today. However, this example only shows the possibilities of what types of returns you can experience. Again, what Wall Street won’t tell you!
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Investing in real estate, bonds, cryptocurrencies, private companies, gold, or individual stocks is literally IMPOSSIBLE in a 529 plan. However, Coverdell can use non-recourse debt (or leverage) to make even small investments that can pay huge returns and quickly accelerate your college savings account.
Example #2: I have had countless clients set up their LLCs to own rental properties using their child’s Coverdell account as a minor owner in the LLC. Later when the property is sold and the LLC is liquidated, all of the investment money (attributed to Coverdell’s ownership in the LLC) is returned to Coverdell tax-free for college use. Rates of return on rental properties, including appreciation, cash flow, and mortgage abatement, are exponentially higher than the rate of a 529 government financial industry support plan. How does a Coverdell Education Account work?
Like a Roth IRA, all Coverdell investments will grow tax-free and all qualified education expenses will be tax-free. These distributions would include qualified elementary and high school expenses—not just college expenses. (More below).
Users do not have to be connected to the Depositor. In other words, the beneficiary can simply be a young person whom you want to benefit from and help in their future college education. However, users must be under the age of 18 when a Coverdell is opened on their behalf. Additionally, contributions of $2,000 per year can only be made up to the date of their 18th birthday (not the year they turn 18).
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Example #3: You just had a new baby and a family friend opens a Coverdell for your child as a gift. They put $1,000 toward future educational expenses. Now you want to open another Coverdell account for your child in the same year. You can open a new account, but the TOTAL contribution for the user, per year, is $2000. You can only put $1000 into the account and your child would then have (2) Coverdell accounts worth $1000 each.
The maximum Coverdell contribution in 2022 is $2,000 per beneficiary, and if the beneficiary has multiple Coverdell accounts. The total contribution is still limited to $2,000 across all accounts (note and don’t worry… the contribution limit is not a drawback, as I’ll explain further below). Contributions can be made until April 15 for the previous year.
Example no. 4: So if your child is 12, it’s currently May 1, 2022, and their birthday is July 15, you could contribute $12,000 between now and their 18th birthday. (Nothing before 2021, that is after April 15, 2022). You can pay $2,000 now for 2022, then $2,000 in 5 more years. (Note that the $2000 in 2027 is for July 15th and their 18th birthday). That may not sound like much with today’s college education costs, but wait until I discuss the secret weapon within the ESA below. Who can be a grantor or depositor
It is important to understand who is entitled to make a ‘contribution’ to Coverdell for a beneficiary. This is because there are income limits on who can be a depositor, more on that later. However, coverdell depositors can be any of the following:
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Now, the current “front door” rule in 2022 is that no one with more than $110,000 (single) or $220,000 (married filing jointly) in adjusted gross income can make a Coverdell contribution on someone’s behalf.
Even so, 529 Plan proponents also like to talk about the Coverdell income contribution limit, but again I don’t think that’s a problem. This is because there is a legitimate ‘backdoor’ method. During the years when it is necessary for the client, we use a simple ’roundabout’ or ‘back door’ method to make contributions.
Example of a backdoor method: Mom and/or Dad can open a Coverdell account and control it as the “responsible person”, but the Depositor can be someone else. So this method is common for mom and/or dad to gift money to a friend or family member (subject to applicable gift rules and restrictions, of course), and the gift recipient makes a deposit to Coverdell on the beneficiary’s behalf. Simple, direct, allowed and nothing wrong with that! Control of the responsible individual
This is a wonderful feature of Coverdell, because the responsible person can be involved in Coverdell from the beginning and help to get to the front and finally carry it over the finish line when all the funds are distributed.
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In practice, the responsible person is typically the one who “opens” the ESA and coordinates the contribution. EVEN IF they are not ESA donors themselves due to income restrictions (see below).
Most importantly, the responsible person can change the named ‘User’ at any time! The only caveat is that the ‘transfer’ or ‘transfer’ to the new beneficiary must be a qualifying family member ‘of the original beneficiary’, NOT the responsible person OR the donor/donor. To meet the beneficiary switching rules, the new beneficiary must be under the age of 30 and one of the following family members to the current Coverdell beneficiary before switching:
Important note during formation: Once a Coverdell is established, be sure to indicate in the formation documents that the responsible party will continue to serve in this role after each beneficiary turns 18. IF this selection is not made, then the user will
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