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A Coverdell education savings account (ESA) is one way to save for education expenses on a tax-advantaged basis. The ESA allows you to invest in potentially higher-earning assets, helping to supercharge your returns. You can invest the ESA yourself or have a financial advisor pick out investments that are well-suited to your risk tolerance and time horizon.
Here are the investments available in a Coverdell ESA and what else you need to know about the account.
What investments are available in a Coverdell ESA?
A Coverdell account can invest in many different assets, but not all Coverdell accounts offer a wide selection, depending on the type of financial institution you’re working with. The Coverdell ESA is available at major financial institutions, such as banks and online brokers, and your choice of the institution has a huge impact on which investments are available.
If you open a Coverdell at a bank, you’ll be able to invest in the bank’s accounts and products. So, you’ll be able to open savings accounts and CDs, where the returns are safe and steady but not exactly outstanding. If you go this route, try to use one of the best high-yield savings accounts or a bank offering one of the best CD rates to get the best returns.
If you’re working with a broker, then you’ll have literally thousands of investment choices, and you’ll need to decide what to invest in. A top broker lets you invest in the following assets:
- Stocks
- Bonds
- Mutual funds
- Exchange-traded funds (ETFs)
- Other investments available at the broker
That’s a wide range of available choices, and as you select investments, you’ll need to carefully consider your risk tolerance and when you’ll want to withdraw the money. Those factors will help determine which investments are appropriate for you. For example, if you need the money in a few years, you probably want a safer choice, such as bonds. If you have five or more years until you can tap the money, you can go with a higher-return choice, such as stocks or stock funds.
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But if you start investing early, you can safely use higher-risk, higher-return investments, such as stocks and stock funds. You could likely earn much more than in a bank account.
How a Coverdell ESA works
A Coverdell ESA allows you to save on a tax-advantaged basis for qualified education expenses from kindergarten to college. It’s lesser known than a similar education savings plan called a 529 plan, and the Coverdell has some important differences from the 529 plan.
A Coverdell account allows you to save up to $2,000 per year per beneficiary, for joint filers earning modified adjusted gross income (MAGI) of $190,000 or less. The contribution cap is gradually reduced for joint filers with a MAGI between $190,000 and $220,000.
Any earnings in the account — such as interest, dividends or capital gains — are tax-free, making it easier for the money to compound. Withdrawals are free from federal tax as long as the funds are used for qualified education expenses, including tuition, books, supplies, uniforms and other closely related costs.
A Coverdell ESA offers access to a broader selection of investments than a 529 does, though a 529 plan allows a much larger annual contribution. An individual can participate in both accounts without penalty, offering more potential ways to save.
You’ll need to consider whether a Coverdell ESA makes sense for your situation. A good financial advisor can help you decide whether the account works for your needs and help you make the right kinds of investments, too.
Bottom line
A Coverdell account can offer you a variety of investment options, and you’ll want to take full advantage of the extra potential in the available higher-return investments, if you’re able. Working with an advisor can help you make a smart decision and get the most from your ESA.
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