Coverdell to 529 Conversion: A Smart College Savings Strategy

The Coverdell education plan is quickly being eclipsed by the 529 plan in most states. Both plans offer options to deduct money placed in a college savings account from your taxes annually. Both restrict uses for the money in the future. However, with the Coverdell plan, 2010 is the last year these savings can be spent on primary education. For this reason and more, many individuals will choose to convert to a 529 plan.

Benefits of Conversion

The main benefit looming over many parents right now is assuring the money in an education plan can be used for early education. Private preschool, elementary and high schools are more common today than they were than the Coverdell was introduced, and many parents are facing a difficult expense when the change occurs. Moving your money into a 529 will solve this problem. Further, the contribution limits for a Coverdell will also go down in 2010 from $2,000 annually to only $500 of deductible funds each year. This limit greatly reduces the benefits these plans once posed because it is hard to save for the expenses of education with such a low contribution annually. Each state sets the limit for 529 plan contributions, but as a general rule the contribution limit is higher. Limits for 529 plans are set on a lifetime basis and may cover the entire education cost for a designated beneficiary. This means the accounts can hold hundreds of thousands of dollars.

Converting to a 529 Plan

Converting from a Coverdell to a 529 is relatively simple. The first step is to pick a 529 plan. You may choose one your own state has to offer, but you may also choose an out of state plan. Some states allow you to deduct contributions to out of state plans. You will also want to learn whether the plan you choose requires you to spend the money in a specific state. Today, most 529 plans can be used to pay for education anywhere in the country. Next, simply take a qualified education expense distribution from your Coverdell. Converting to a 529 does qualify as long as the conversion goes through within one year. To make things easier on yourself, you may set up an escrow account or have the deposit go directly into your new account. You may want to set up a custodial 529 account since a Coverdell is also a custodial account. This is not an IRS rule, but it can limit the possibility of unforeseen tax liability.

Considerations for your Conversion

When converting to your 529 plan, consider the immediate needs you have from the account. You may need a portion of the funds you are converting to pay for education expenses this year. If this is the case, consider your states deduction guidelines. You may find it is beneficial to first convert the funds into a 529 and then use them for your qualified education expense. You may find the opposite is more beneficial in your case.