1. Coverdell Education Savings Account: Introduction
  2. Coverdell Education Savings Account: Who’s Eligible to Contribute?
  3. Coverdell Education Savings Account: Opening an ESA
  4. Coverdell Education Savings Account: Avoiding Taxes on Distributions
  5. Coverdell Education Savings Account vs. 529 Plan
  6. Coverdell Education Savings Account: Conclusion

If you’ve determined that you’re eligible to contribute to an ESA for your child or another beneficiary, the next step is opening your account. You can open a Coverdell ESA at a bank, credit union, mutual fund company or brokerage firm. The question is, which one is the right choice?

Weighing Your Options

Just like any other investment opportunity, it’s important to consider the fees, variety of investment options, average returns and minimum deposits involved. A good place to begin in choosing where to open your Coverdell ESA is by talking with people and places you trust.

  • Ask family members and friends who have ESA accounts where they have theirs. What do they like about their account? What do they dislike? Would they recommend it to others?  
  • Talk to your bank and financial advisors. Does your bank offer a Coverdell ESA? What about your local credit union? Does your financial advisor have any recommendations? You can take it a step further and find out if mutual funds you currently own have ESA options, too.
  • Research Coverdell accounts online. If you don't know anyone with an ESA, you may be able to find guidance online. Search for professional ratings and personal opinions online. Then, research financial institutions that are highly recommended to get the details on minimum opening deposit, fees, procedures for making deposits and investment performance.

The more due diligence you’re prepared to do, the easier it may be to find a Coverdell ESA that suits your needs and those of your child. And remember, if you open an ESA but you become unhappy with it, you can open a new account elsewhere and transfer those assets.

Organizing Multiple Accounts

If grandparents, other relatives or friends want to open and contribute to an ESA on behalf of your child, you’ll need to coordinate those accounts together to ensure that you don’t exceed the annual contribution limit.

Each contributor can open their own account, but you’ll need to keep track of the money. This serves two purposes: It allows you to monitor how much is being saved towards your child’s education, so you know how much of a gap needs to be filled; and it can help you avoid making excess contributions and triggering the excise tax penalty.

If you’d like to simplify things, you could open a single Coverdell ESA for each child in your family, then ask family members to make contributions to that one account. This can reduce some of the headaches of keeping tabs on what’s being saved.

Choosing Your Investments

A Coverdell ESA is an investment tool and contributions can be invested in a number of ways, including mutual funds, stocks, bonds and money market funds. Certain investments are excluded, such as collectibles.

As you’re evaluating investment choices, zero in on the performance of those investments and the overall cost. What you want to consider here is whether the fees of an investment are justified by the returns. An investment may be a strong performer, but it may not be worth it if you’re handing over a significant amount of earnings to fees.

Also, be aware of how what you’re investing in aligns with your risk tolerance. For example, target-date funds are a popular option in Coverdell ESAs. These funds have an asset allocation that adjust automatically, based on your child’s expected college attendance date. These funds take the guesswork out of choosing an asset allocation but if you prefer to take more – or less – risk, they may not be an ideal choice.

If You Have More Than One Child

The $2,000 annual contribution limit applies per beneficiary, so it’s possible to have more than one Coverdell ESA if you have multiple children. If you can’t afford to fully fund each child’s account for the year, you could ask grandparents or other relatives to make up the difference. Alternately, you could choose to fully fund the oldest child’s account until he or she turns 18, then focus on maxing out the next child’s account until age 18, and so on.

If you’re able to contribute the full $2,000 for each child annually and you have more funds available to save, you could divert some of them into a 529 savings plan. You can find an in-depth comparison of Coverdell ESAs and 529s a little later in this tutorial.

Key Takeaways for Opening a Coverdell Education Savings Account

To recap, here are the most important things to keep in mind when opening a Coverdell ESA:

  • Choose wisely where you open your account. If your child is a newborn, he or she will have this account for 30 years, so you want to work with a financial institution you can trust.
  • Remember to review your investment choices carefully. Know what you’re investing in before funding your account and evaluate your investments regularly to make sure that they’re still a good fit for your investing objectives.
  • Go over the fees and minimum deposit guidelines. Be clear on what you’re paying in investment and management fees, as well as how much you’re required to invest initially to open your account.
  • Keep track of all contributions to multiple accounts, if your child has more than one. Good recordkeeping can help you avoid tax penalties and ensure that you’re maximizing savings opportunities. 

Coverdell Education Savings Account: Avoiding Taxes on Distributions
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