You have expressed an interest in saving for your child’s education. There are two popular savings programs that have distinct tax advantages:
- Qualified tuition programs (QTPs) and
- Coverdell education savings accounts (Coverdell ESAs).
A Qualified tuition programs (QTPs) is a program established and maintained by either a state (or an agency or instrumentality of a state) or an eligible educational institution under which you can prepay, or contribute to an account that will be used to pay, a student’s tuition and related expenses. An eligible educational institution includes virtually all accredited public, private, and religious schools. In addition to tuition, expenses for which these funds can also be used generally include:
- fees,
- books,
- supplies, and equipment required for enrollment or attendance;
- computers or peripheral equipment, computer software, and internet access and related services;
- special needs services; and
- room and board.
Contributions to QTPs are not deductible. On the other hand, because a QTP itself is tax-exempt, distributions up to $10,000 per year are generally nontaxable. However, in certain instances, taxes may apply. While it is possible to lose money on an investment in a Qualified tuition programs (QTPs), it is not common. However, should this occur, a limited deduction may be available. The features and requirements of a Qualified tuition programs (QTPs) depend on whether it is established by a state or by an educational institution.
Under a Qualified tuition programs (QTPs) established by a state, you can purchase tuition credits or certificates on behalf of a designated beneficiary that entitle the beneficiary to a waiver or payment of his or her qualified education expenses (i.e., you can prepay the beneficiary’s education expenses), or you can make contributions to an account that is established for the purpose of paying the qualified education expenses of the designated beneficiary of the account (Code Sec. 529(b)(1)).
Under a Qualified tuition programs (QTPs) established by an eligible educational institution, you can purchase tuition credits or certificates on behalf of a designated beneficiary that entitle the beneficiary to a waiver or payment of qualified education expenses (i.e., you can prepay the beneficiary’s education expenses). Eligible educational institutions cannot offer the account option that is available for Qualified tuition programs (QTPs) established by states. A program established by an eligible educational institution must obtain a ruling or determination that the program meets the requirements of a QTP and it must hold any prepayments made by you in a qualified trust.
Generally, the designated beneficiary of a Qualified tuition programs (QTPs) is the student (or future student) for whom the Qualified tuition programs (QTPs) was established to provide educational benefits. However, if you have an established Qualified tuition programs (QTPs), you can change the designated beneficiary to a family member of the initial designated beneficiary without any tax consequences.
A Coverdell education savings account (Coverdell ESA) is a tax-exempt trust created or organized in the United States solely for the purpose of paying the qualified education expenses of a designated beneficiary of the trust. Qualified education expenses include both qualified higher education expenses and qualified elementary and secondary education expenses The tax benefit of using a Coverdell ESA to pay educational expenses is that the distributions made from a Coverdell education savings account (Coverdell ESA) are generally tax-free. Thus, like the Qualified tuition programs (QTPs), there is no income tax on earnings from amounts contributed to a Coverdell education savings account (Coverdell ESA). Also like a Qualified tuition programs (QTPs), contributions to the Coverdell ESA are not deductible.
To qualify as a Coverdell education savings account (Coverdell ESA), the trust must be designated as a Coverdell education savings account (Coverdell ESA) and the designated beneficiary must be under age 18 or a special needs beneficiary when the trust is created or organized. The trustee must be a bank or an entity approved by the IRS, and the written governing instrument creating the trust must provide that:
- The only contributions that will be accepted are cash contributions;
- No contributions will be accepted after the date the designated beneficiary turns age 18;
- No contributions (except rollover contributions) will be accepted to the extent they would result in aggregate contributions for the tax year in excess of $2,000;
- The trust assets (i.e., the cash contributed to the trust) cannot be invested in life insurance contracts;
- The trust assets (i.e., the cash contributed to the trust) cannot be commingled with other property except in a common trust fund or common investment fund; and
- The balance in the trust must be distributed within 30 days of the designated beneficiary’s 30th birthday (unless he or she is a special needs beneficiary) or the designated beneficiary’s death.
Generally, the designated beneficiary of a Coverdell education savings account (Coverdell ESA) is the individual named in the trust’s governing instrument to receive the benefit of the trust funds. However, like a Qualified tuition programs (QTPs), if you have an established Coverdell education savings account (Coverdell ESA) , you can change the designated beneficiary to another family member of the initial designated beneficiary without any tax consequences as long as the new beneficiary is under age 30 or a special needs beneficiary.
Overall, the Qualified tuition programs (QTPs) plan is more flexible. There is no age limit for contributions and withdrawals under a Qualified tuition programs (QTPs). For a Coverdell education savings account (Coverdell ESA), however, the beneficiary must be under 18 to receive contributions and must generally use the assets before age 30. Also, the Qualified tuition programs (QTPs) plan contribution limits are substantially higher than the $2,000 allowed for a Coverdell education savings account (Coverdell ESA) and there are income limits for contributors to a Coverdell education savings account (Coverdell ESA) whereas there are not for a Qualified tuition programs (QTPs). Finally, some states allow state tax deductions for a QTP but not for a Coverdell education savings account (Coverdell ESA) .
There are many other considerations in choosing the right college savings plan for your personal needs. If you would like to discuss this further, please call my office to set up an appointment.
Please contact the office of Don Fitch Accountancy at (760)567-3110 or Email Don.Fitch@CPA.com if you have any questions or would like additional information.
DON FITCH, CPA
74478 Highway 111 #3
Palm Desert, CA 92260
Toll Free: (877)CPA-Help or (877)272-4357
Cell: (760)567-3110
Fax: (760)836-0968
Email: DonFitchCPA@paylesstax.com
Website: https://www.paylesstax.com
P.S. My firm is based upon referrals. Please feel free to refer my firm to anyone you know that is looking for a new CPA and/or tax preparer. Thank you in advance.
(Updated 05032021-1 320-320)