Account can make college savings grow

Q. We've just had a baby and we're planning to start saving right away for her college education. Any suggestions?

A. One of the best ways to start is to open a Coverdell Education Savings Account, formerly known as an Education IRA.

Named in memory of the late Paul Coverdell, a Republican senator from Georgia, a Coverdell ESA allows you to set aside up to $2,000 a year for your child's college costs. Withdrawals are tax free if used for approved educational expenses.

There are several advantages that Coverdell ESAs have over the Section 529 college savings accounts that have been created by the states to help parents fund their children's education, said Geordie Crossan, a certified financial planner who heads NBS Financial Services Inc. in Westlake Village, Calif.

In addition to paying for college tuition, books and other expenses, you can use Coverdell proceeds for kindergarten through high school educational expenses, Crossan pointed out. Section 529 plans can only be used for college.

"Another advantage is increased investment flexibility," he added.

That's because there are limited fund offerings through Section 529 programs, while investors can select stocks, bonds, mutual funds or other investments for their Coverdell ESAs, Crossan said.

Most small savers meet IRS qualifications to open the accounts. Married couples filing jointly must have adjusted gross income of $190,000 or less, while single filers must have incomes of $95,000 or less.

But even parents who earn more than the maximum have the option of "gifting" $2,000 a year to their child to fund his or her own account, Crossan said.

Joseph F. Hurley, founder and chief executive of Savingforcollege.com in Pittsford, N.Y., said Coverdell ESAs generally are less expensive for savers because "there are typically no program management fees as there are in Section 529s."

Still, he suggests parents look at Section 529s, too.

Some states allow parents to take an income tax deduction for funding Section 529 plans sponsored by their home states, Hurley pointed out.

In addition, families can contribute much more each year to Section 529 plans than to Coverdell ESAs.

Crossan said he sometimes recommends families first fund a Coverdell ESA for a child, especially if they expect the child to go to a private elementary or high school. Then, if they have more money available, they can also fund a Section 529 plan account, he said.

Technically, the assets in a Coverdell ESA must be fully distributed by the time the beneficiary is 30, Crossan said. "But the plan may allow the custodian to change the beneficiary to another family member," he said.

Internal Revenue Service guidelines on Coverdell ESAs can be found in IRS Publication 970 titled "Tax Benefits for Higher Education" or at the IRS Web site, www.irs.gov.

On the Net:

Crossan's site: www.NBScompanies.com

Hurley's site: www.savingforcollege.com