The Independent Investor: An Educational IRA for Kindergarten and Above

Most savers are familiar with state-sponsored 529 Plans, a tax-advantaged savings plan to help put your children through college. However, there is another savings plan that could assist you in meeting the bills for school Grades 1 through 12 as well as college. It is called a Coverdell Education Savings Account (ESA).

This plan is ideal for families with multiple children or who want to start saving for their children's educational needs early in their lives. In addition, if you are thinking of sending your child to an independent or private school (or prep school) prior to college then this ESA is meant for you.

You can contribute $2,000 annually to an ESA, although similar to a Roth IRA, contributions are not tax deductible. However, the earnings on contributions and distributions are tax-free as long as they are used for educational purposes. The tax-free money can apply to tuition, room and board, computers, laptops, supplies, tutoring and transportation as long as they are legitimate educational expenses. Attendance at colleges, secondary or elementary schools, as well as vocational schools and other post-secondary educational institutions (whether public, private or religious) are eligible.

Take the example of my grandson, Miles, he is 16 months old, lives in Manhattan and faces horrendous future educational costs. His mother wants to begin saving for his education now. I can't blame her. There are kindergartens in the Big Apple that will set you back $40,000, if you are so inclined. Private grammar and high schools could easily cost $100,000 plus.

Now $2,000 a year in savings doesn't sound like much if you live in Manhattan, but it will certainly help and elsewhere it could be a windfall for many lower-income families. If invested properly, five years of $2,000 contributions could generate a considerable amount of money. Money that would certainly pay for some of the expenses every child will incur through high school and beyond.

So what, you may ask, is the downside to ESAs? The $2,000 contribution per year, per student is negligible compared to the $14,000 a year you can stash away in a 529 Plan. There is also an income limit which kicks in for single taxpayers making over $110,000/year and married couples making over $220,000.

You also have to use the money before the child turns 30 years of age, otherwise the earnings (not the contributions) will be taxed and a 10 percent penalty will also be applied. You could avoid that by simply rolling over the full balance to another ESA for another family member.

The American Taxpayer Relief Act signed into law January 2nd removed any lingering uncertainty concerning the future of ESAs. They are here to stay just like 529 Plans. But unlike their bigger more popular brethren, you can manage your ESA yourself while saving hefty expenses that 529 Plans charge.

Many savers have also been disillusioned with the performance of their 529 Plans thus far. That is an important point since many hoped that the growth of these plan contributions would at least match the rate of increase of educational costs, which are about 6 to 7 percent a year.

If one can afford it, most planners recommend that families contribute to both plans. You still have time to open an ESA account and make a $2,000, 2012 ESA contribution. You can also contribute another $2,000 for 2013 if you are so inclined. The paperwork involved is no more onerous than a standard IRA application that you can obtain from most brokers or your local bank. Do your kid a favor, open an ESA today.

Bill Schmick is registered as an investment adviser representative with Berkshire Money Management. Bill’s forecasts and opinions are purely his own. None of the information presented here should be construed as an endorsement of BMM or a solicitation to become a client of BMM. Direct inquires to Bill at 1-888-232-6072 (toll free) or email him at Bill@afewdollarsmore.com.