- Coverdell IRAs allow you to contribute $2,000 to the IRA per year for your child's college education. This money may be invested in mutual funds or other investments to help grow the college fund. To make the full contribution, you must have an adjusted gross income under $95,000. If it is more than this amount, your contribution limit is gradually decreased based on your income level.
- The advantage of the contributions to a Coverdell IRA is that the contribution amount is non-deductible. While this may not help you immediately for your taxes, it will help you when you withdraw money for college expenses, because withdrawals from Coverdell IRAs, including the earnings on investments, are tax-free. This gives your child more money for college costs than you would have had without the Coverdell.
- The disadvantages to Coverdell IRAs are that they may be used only for college education expenses. If you make withdrawals for any other purpose, you must pay ordinary income taxes plus a 10 percent penalty on the money you withdraw from the plan. Additionally, the money must be used before your child reaches age 30, or, in most cases, you pay income tax plus a penalty on the amount remaining in the Coverdell IRA.
- If you are unsure whether your child will attend college, you might want to consider alternative funding strategies. For example, if you have money in a Roth IRA, the contributions to the Roth may be withdrawn without paying tax or penalties. This money may be used for any purpose. Additionally, you may consider using a cash value life insurance policy. Cash value life insurance may build cash values slowly, unless you are using a high early cash value product or a contract that allows access to most or all of your contributions plus interest within the first 10 years. In some instances, this money may be borrowed from the policy or withdrawn to pay for college expenses.