Two popular savings accounts to save for your children are the Coverdell Education Savings Accounts (ESAs) and custodial accounts, such as UGMA/UTMA. There are always pros and cons to any type of savings account. It’s up to you to learn the differences between the Coverdell vs. a custodial account to make sure that you’re choosing the best option for your family, financial situation, and your child’s future goals.
As a parent, you spend a lot of time dreaming about your child’s future and working to ensure they have the tools necessary to reach their full potential. With so many options available to save for your child’s education and future ambitions, it can be challenging to know which one is best for your unique situation.
Here’s your guide to Coverdell vs. custodial accounts to help you make an informed decision and become successful in providing your kids with a great start in life.
Coverdell vs. Custodial Account
In this article, you get to compare two of the most common types of savings accounts that parents utilize to save for their children’s future educational expenses. These are a couple of custodial accounts, the UGMA and the UTMA, and the Coverdell ESA. Each type of savings account has its benefits and downsides. You need to look at each one closely before deciding if one is right for you.
Custodial Accounts: UGMA/UTMAs
The Uniform Gift to Minors Act (UGMA) and Uniform Transfer to Minors Act (UTMA) are savings accounts where you place money into them for your child’s future educational needs. When your kid reaches the age of majority for your state, the account automatically transfers to the child. You’re the custodian for the minor child.
Coverdell ESA
The Coverdell ESAs are another custodial account that helps you save for your child’s future educational needs. These accounts are created by each state. You’ll need to see if the state you live in offers a Coverdell ESA. Once your child becomes an adult, the control of the account becomes theirs.
The Differences Between Coverdell vs. Custodial Account
Before deciding between these accounts, you need to learn more about them. Your child’s future financial situation and personal goals are unique, making it essential that you isolate the best type of account for your family. Here’s a brief comparison of the differences between a Coverdell vs. a custodial account to help you decide.
- Who Controls the Account: All of these accounts are custodial accounts, which means that while your child is a minor, you or someone else you designated controls the account. However, once your child reaches the age of majority in your state, the funds transfer to their control. You lose any say on how the funds are spent or invested after this point.
- Contribution Limit: With the Coverdell ESAs, you and your family members are limited to placing $2,000 per year into the account. Neither the UGMA nor the UTMA accounts have a contribution limit either per year or lifetime. However, money put into these accounts is considered a gift, and you and your child are subject to tax consequences for a certain threshold.
- Income-based Restrictions: The Coverdell ESAs are only available to families who fall under a specific income level. You’ll need to determine the current income level to see if your family is eligible. Neither the UGMA nor the UTMA accounts have any income-based restrictions.
- Tax Benefits: The Coverdell ESAs are a tax-deferred account, which means you don’t pay taxes on the income you place in this account and saves you money on your yearly tax bill. You don’t receive any tax benefits at the time of deposit, but you will as your child uses the funds.
- Tax-free Withdrawals: In most cases, the IRS will waive federal taxes on your Coverdell ESAs when it’s used for a child’s education and other covered expenses. However, the state you live in might apply income taxes to the funds. With the UGMA and the UTMA accounts, when your child files as part of your taxes and uses the funds for education, you won’t pay taxes on the first $1,100 and only a 10% income tax rate on the second $1,100. Any additional funds are taxed at the parent’s tax rate.
- Can Minor Accounts Be Changed: The UGMA and the UTMA accounts don’t allow any changes to the account once it’s established. The Coverdell ESAs allow for some changes depending on the circumstances.
- Effect on Federal Financial Aid: The UGMA and the UTMA accounts are considered an asset of your child and affect the financial aid amounts depending on the funds available.
Coverdell vs. Custodial Accounts
You want to offer your kids the best starting point that you possibly can. It’s your goal to help them reach their potential and dreams. If you prefer a traditional route, you can opt for the Coverdell ESAs or a custodial account. However, they don’t offer the same flexibility.
