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With the rising cost of education, a Coverdell Education Savings Account (CESA) can be a powerful tool to help combat education expenses, potentially reduce dependence on financial aid, and receive tax benefits. Understand how a CESA works, eligibility, how you can grow your CESA and more to see if this account may be right for you.
1. What is a Coverdell Education Savings Account (CESA)?
A Coverdell ESA is an account set up for paying qualified education expenses for a designated beneficiary, according to the IRS.
2. How does a self-directed CESA work?
Equity Trust offers a self-directed CESA, which allows you to invest in almost any asset, tax free or tax deferred, while saving for education costs. Investing funds contributed to a CESA may potentially lead to the overall growth of the account, in a tax-advantaged fashion.
Many Equity Trust clients are primarily investing in alternative assets, beyond traditional stocks, bonds and mutual funds. Some of these alternatives include real estate, private lending, promissory notes, tax liens and many others.
A Self-Directed CESA Case Study
In 2017, Brian opened Coverdell accounts for each of his four children. He saw the savings potential: money saved in a CESA can be withdrawn tax-free when used for qualified education expenses.
An active real estate investor, Brian decided to try to grow his children’s accounts using self-directed CESAs.
A CESA’s annual contribution limit is $2,000. Brian was concerned that it would take a while to build up enough capital in the account to be able to invest in real estate. His purchasing power increased when he learned that he could partner with other self-directed accounts to make investments.
Brian thought it would be difficult to find a suitable investment property for less than $50,000 in the city of Nashville, but before long he found a vacant lot in the city for $8,000.
He partnered three of his children’s self-directed CESA accounts to purchase the lot. One child’s CESA invested $4,000, and his two other children’s CESAs each invested $2,000.
Brian saw potential in the lot because he spotted new housing construction nearby, as well as a mobile home park that was on the market.
“As I reviewed the potential of the area, I believed the value was going to change once they sold that mobile home park,” Brian recalls. “Once the mobile home park sold, additional houses were built continuing to push values up.”
The land was sold 60 days later for $60,000. The sale proceeds returned the CESA accounts in the same proportion as was used for the purchase.
Brian had been investing in real estate for a while before he was aware that he could self-direct his retirement account, CESA or other accounts into real estate and other alternative investments.
Between his and his wife’s retirement accounts and his children’s CESAs, Brian’s family now has a total of eight accounts at Equity Trust.
Video: Coverdell Education Savings Account FAQs
3. What can a Coverdell Education Savings Account be used for?
A CESA can be used to fund qualified education expenses recognized by the Department of Education through an accredited institution.
According to IRS Publication 970, the expenses can be either qualified for higher education expenses or qualified elementary and secondary education expenses.
Some examples of qualified education expenses may include tuition, room and board, books, supplies, equipment, uniforms, software, academic tutoring, special needs services, and others.