‘Fiscal Cliff’ Deal Puts Coverdell Education Savings Accounts Back in Spotlight

The American Taxpayer Relief Act of 2012 (ATRA), the act which averted the so-called “fiscal cliff,” will have a wide-ranging span of ripple effects. One affected area is education savings, where the new law has taken Coverdell Education Savings Accounts out from the shadows and put them in a new light.
In 2002, Congress re-worked a seldom-used program, Education IRAs, re-branding them as Coverdell Education Savings Accounts, or ESAs. The re-tooled ESAs had several distinctions from the old Education IRAs, making them much more attractive. ESAs allowed families to contribute up to $2,000 annually, as compared to Education IRA’s extremely low annual of limit of $500, and ESAs allowed families to save for K-12 expenses, not just-post-secondary costs.

The 2002 law, however, created a provision that would sunset several of the advantages of the Coverdell ESA in 2010. Congress later pushed that sunset back to 2012. As the sunset date drew nearer, the uncertainty surrounding ESAs led families to focus more of their savings on Section 529 college savings plans. Major investment companies shied away from ESAs and their cloudy future. According to Forbes magazine, Vanguard ceased offering ESAs in 2011, and Fidelity never offered them.

The ATRA, however, removed that shroud of uncertainty from ESAs, abolishing the sunset provision and making permanent the favorable terms originally crafted in 2002. With ESAs, contributed funds, while not tax-deductible, grow tax-free and are also tax-free when taken out for use on education expenses. The new law also makes more families eligible to use ESAs. Without the ATRA, the phase-out income limit for married couples filing jointly would have dropped back to $150,000 annually, while the new law preserves the current number of $190,000. With these advantages permanent, ESAs offer a variety of potential benefits to families. The accounts allow families to open an account for each child. Families may use funds from ESAs for education expenses from college all the way down to kindergarten, making ESAs especially attractive to families with children in private or religious elementary or high schools. A qualifying education expense is also broader under the ESA than a 529. For example, a family may use money from an ESA to purchase a new laptop computer, as long as one member of that family is a student. That family could only use 529 funds if the student’s college or university required the student to purchase that computer.

Additionally, ESAs potentially appeal to families who want greater control over the investment of the funds. In addition to offering a broader spectrum of eligible education expenses on which families may spend funds, money in ESA may be invested in a wider array of ways. With an ESA, a family may invest nearly any mutual fund or ETF, or even individual stocks, whereas, with a 529 plan, families may only choose from the options offered by that individual plan sponsor.

Observers remain uncertain whether the ATRA’s locking in of the ESA’s advantages will draw more users to ESAs and 529 plans. According to a December 2012 US Government Accountability Office report, fewer than three percent of eligible families contributed to an ESA or 529 plan in 2010.

The tax attorneys at Samuel C. Berger, P.C. and the CPAs at S.C. Berger, P.C. assist families in New York and northern New Jersey seeking to save money for their children and grandchildren’s education expenses, and do so in the most tax-advantageous way possible. To schedule a consultation, contact us online or call (201) 587-1500 or (212) 380-8117.

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