By now, you might have heard that that you are able to contribute up to $2,000 annually to a Coverdell Education Savings Account, formerly called the Education IRA, compared to the previous $500 yearly maximum. But what many people don't know is that tax-reform legislation passed recently greatly expands what you can spend this money on.
Previously your Education IRA could only be used to pay for college expenses. But now in 2002, you can tap these funds tax free to pay for a gamut of qualified school-related expenses not only for college but for private and public primary and secondary educational institutions. Qualified expenses may include:

• Computer equipment and software (no games) used by the student for educational purposes and other household Members
  
• Internet service used by the student for educational purposes (i.e. research for a term paper) and other household members
  
• Tutoring
  
• School uniforms
  
• Books and school supplies
  
• Transportation
  
• Room and board and tuition
  
• Extended-day school programs
  

Not only have contribution limits increased, allowing you to save more for your children's education, but the list of qualified educational expenses also has grown significantly. By paying these and other education-related expenses with your Coverdell Education Savings Account, you pay no taxes on your withdrawals, which gives you more buying power.
For example, if you contributed the $500 maximum to a Coverdell Education Savings Account last year for your newborn child and then contributed the $2,000 maximum this year and every year until your child turns six and enters kindergarten, you could potentially accumulate $15,465 at an 8 percent annual compounded rate of return,* All of that money can be withdrawn tax free, which is a much better deal than if you had saved that money in an interest-bearing savings account and then had to pay taxes on the interest you earned.

Consider using a combination of a Coverdell Education Savings Account and a 529 college savings plan if you want to save both for your children's college and primary and secondary school education. The 529 plans can only be used for college expenses, but the Coverdell account could be available to pay for school-related expenses until college. However, unlike other savings plans, anyone at any income level can contribute to a 529 plan. Beginning this year, 529 plan withdrawals also will be federally tax free. In addition, U.S. residents can participate in any state's 529 plan and set up accounts for their children, grandchildren, friends or even themselves. But keep in mind that each state's plan will invest your contributions differently and levy its own costs and fees. Be sure to shop around for the 529 plan that best fits your needs.

Coverdell Education Savings Accounts and 529 plans are a one-two punch that is hard to beat. With college expenses increasing faster than inflation, parents need all the help they can get. Your financial consultant can help you determine which savings plan, or combination, is the best strategy for you.

* Example is for illustrative purposes only and do not reflect the performance of any particular investment.

Copyright
This article was provided by Steven J. Hall, CFP, (815) 744-2664 of A.G. Edwards & Sons, Inc., Member SIPC.