Volume 13, Issue 11

Education Funding WITH A COVERDELL ESA


If you’re thinking about ways to fund your child’s education, the federal government has provided an incentive—the Coverdell Education Savings Account (Coverdell ESA), formerly known as the Education IRA. Contributions are not deductible, but tax-free withdrawals can be made when used to pay for eligible education expenses.

There are, however, income eligibility limits for parents who wish to open Coverdell ESAs for their children. The ability to make contributions phases out for single taxpayers with adjusted gross incomes (AGIs) between $95,000 and $110,000, and for married couples filing joint returns with AGIs between $190,000 and $220,000.

You may contribute up to a maximum of $2,000 annually per child before the designated student reaches age 18. For gift tax purposes, contributions fall under the annual gift tax exclusion limits for singles and married couples ($12,000 and $24,000, respectively, in 2007). Be sure to keep in mind that, if you also contribute to a 529 plan for the same child during the same year, you will need to add these gifts together to determine your gift tax filings.

There is no limit to the number of accounts that may be held in the child’s name or the number of people who may make contributions to a Coverdell ESA—as long as total contributions remain within the $2,000 annual limit per child. If multiple accounts are established and more than $2,000 is contributed in total, the excess is subject to a 6% excise tax penalty. You can, however, eliminate the penalty by withdrawing the excess contributions (and any earnings) before the due date for the beneficiary’s tax return for that year. The withdrawal would be considered income, and it would be subject to taxation.

Coverdell ESAs can be used to pay for more than just college expenses. Funds can also be used to pay for elementary and secondary school expenses, including the purchase of computer systems, educational software, and Internet access for the child.

A Few Holds Barred

The beneficiary must spend a Coverdell ESA by his or her 30th birthday. If the designated child does not use the funds for educational purposes by that age, the account may be rolled over for use by another member of the family who is under age 30. Withdrawals from a Coverdell ESA that are not used for qualified education expenses may be subject to both income taxes and a 10% penalty.

Finally, if you’re hoping your child qualifies for financial aid in college, you may want to think twice about setting up a Coverdell ESA. It’s important to note that a Coverdell ESA must be set up in the child’s name. Financial aid formulas, in determining how much a family can afford to contribute to the cost of college, count assets held in a child’s name much more heavily than those held in the parents’ names.


Increased mobility in today’s society has changed the ways in which we live, work, and play. Compared to previous generations, it is now quite common for work and recreation arrangements to cross state lines, resulting in ownership of property and formal social relationships in more than one state. However, the expanded opportunities created by mobility may come at a price: the increased likelihood that several states may be able to tax your estate when you die. If you were to die today, do you know if more than one state would try to levy death taxes on your estate?

The term domicile generally refers to the place intended to be your permanent home, as distinguished from the term “residence.” Although you could have simultaneous residences in several states, in theory, you can have only one state of domicile at a time.

A problem may arise when theory and reality part company: when separate states reach different conclusions by applying different definitions of “domicile” to the same set of facts. This may result in the apparent inconsistency of more than one state claiming the deceased was a “domiciliary,” and each taxing that person’s estate accordingly.

Under the Uniform Interstate Compromise of Death Taxes Act, the states involved may be able to reach a compromise in a specific situation. However, if the states involved have not adopted the Act or cannot agree on a solution, the estate in question could be fully taxed in multiple jurisdictions.

Establishing Your Domicile

Fortunately, there are steps that can be taken to establish your state of domicile. If you have moved, your “true” domicile may hinge on the number and significance of the contacts you have with your former and present state. Among the significant factors used to make the case are the following:

  • Retention of “historical” home. If you moved but did not sell a long-time residence in a former state, your intention to change your domicile may be questioned.
  • Business relationships. In which state are your significant business contacts located?
  • Location of property. Where is most of your significant real and tangible personal property located?
  • Social connections. Where do you maintain political, civic, religious, and family connections?
  • Time spent. Where do you spend the majority of your time?

While you may feel your intent is clear, it is most likely that your actions will be viewed as the evidence of your intentions. Consequently, simple acts such as changing your voter registration to the new locale, changing your automobile registrations and driver’s license, formally resigning from organizations in your former state, and formally joining organizations in a new state may be viewed as evidence of your intent to change your domicile.

However, it is easy to imagine that under some circumstances, the lines may not be clear-cut. For example, if you moved to another state but maintained significant business and social relationships in your former state, where is your domicile?

In such situations where conflicting evidence exists, a good strategy might be to first determine which state appears most advantageous in terms of death taxes and to determine how domicile is defined in that state. You can then focus on the factors most likely to make the various states involved look favorably upon your domicile.

For specific guidance, please consult your tax and/or legal professionals.


Estate planning has traditionally focused on minimizing estate taxes and directing the disposition of your assets after death. Yet, today, managing your affairs often includes addressing the issue of long-term health care. Consider what would happen if you were to suffer a catastrophic illness or become incapable of managing your own affairs. This situation could occur either through a long, gradual process, such as a deteriorating medical condition, or through a sudden and unexpected accident or illness. If such an event were to happen, who would make your important legal, financial, and health care decisions? On what authority would this individual act?

Fortunately, advance directives—legal instructions that express a person’s wishes regarding financial and health care decisions in the event he or she becomes unable to make them—can help deal with these contingencies.

Legal and Financial Decisions

A durable power of attorney grants authority to another person to make legal and financial decisions on your behalf in the event of mental incapacity. The powers granted can be broad or limited in scope. Some areas a durable power of attorney can assist you with include your personal finances, insurance policies, government benefits, estate plans, retirement plans, and business interests.

Health Care Decisions

In the area of health care decision-making, you may recall the Karen Ann Quinlan case. In 1979, the New Jersey Supreme Court granted permission to her family to disconnect Karen’s respirator, which her doctors believed was prolonging her life in a vegetative state. The case led to the enactment by various states of Natural Death Act Declarations (i.e., living wills).

A living will generally allows you to state your preferences prior to incompetency regarding the giving or withholding of life-sustaining medical treatment. In most states, you must have a “terminal condition,” be in a “persistent vegetative state,” or be “permanently unconscious” before life-support can be withdrawn. The definition of these terms and the medical conditions covered may vary from state to state.

A health care proxy allows you to appoint an agent to make health care decisions on your behalf in the event of incapacity. These medical decisions are not limited to those regarding artificial life-support.

Advance directives by durable power of attorney, living will, or health care proxy are generally inexpensive and easy to implement; they should be considered essential estate planning tools for all individuals, regardless of age. In the absence of such documents, court intervention, involving a great deal of time, expense, and possibly stress to your family, may be necessary to carry out your legal, financial, and health care wishes at precisely the moment when timeliness and ease of action are of the greatest importance.

A Financial Review CAN PAY OFF AT YEAR END

Today, many people find themselves bombarded by a constant stream of financial news from television, radio, and the Internet. Yet, does all this “information age” data really help you manage your finances any better than in the past? The truth often is that the “old-fashioned” practices, such as periodic financial reviews, lead to greater success in the long run. Why not spend a few hours reviewing your finances? The changes you make today could result in increased savings. These are some important items to cover:

  • Analyze your cash flow. When your income is greater than your expenses, the excess is called a positive cash flow. When your expenses exceed your income, the shortfall is termed a negative cash flow. A positive cash flow means that you may have funds you can set aside as savings. A negative cash flow can indicate that it may be a good idea to reorganize your budget to minimize any unnecessary expenses.
  • Develop a plan for special goals. For every financial and retirement goal you establish, identify a projected cost, a time horizon (how long it will take to reach the goal), and a funding method (through savings, liquidating assets, or taking a loan). Consider your goals in terms of a “hierarchy of importance.” The bottom—or “foundation” tier—should include emergency funds to cover at least three months’ worth of living expenses. The middle tier should include such essentials as your children’s education. On the top tier, place less important goals, such as a new car, home renovation, or vacation.
  • Boost your retirement savings. Pensions and Social Security may not provide sufficient income to maintain your existing lifestyle when you retire. Thus, it is essential to identify your retirement needs and plan a disciplined savings program for the future. Maximize your contributions to retirement accounts, and if possible, make “catch-up” contributions. In accordance with the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), taxpayers who are 50 years old, or older, are allowed to make additional contributions to their retirement plans. In 2007, traditional Individual Retirement (IRA) and eligible Roth IRA holders can save an extra $1000 a year, bringing the contribution limit for those 50 years and older to $5,000. Those with eligible 401(k), 403(b), or 457 plans can save an additional $5,000 in 2007, bringing the total contribution for older individuals to $20,500 per year.
  • Minimize income taxes. Why give Uncle Sam any more of your money than is necessary? It is in your interest to take advantage of all income tax deductions to which you are entitled. Consider exploring any possible ways of reducing your income taxes. For instance, under appropriate circumstances, losses or expenses from prior years may be carried over to the next tax year. A qualified tax professional can help you implement a tax strategy that meets your needs.
  • Beat inflation. Your income and retirement savings must keep pace with inflation in order to maintain your buying power. This means that if the inflation rate is currently 3%, you need to achieve at least a 3% annual increase in income just to break even. If your long-term savings plan fails to keep pace with inflation, you may be unable to maintain your current standard of living.
  • Manage unexpected risks. As you undoubtedly know, life can sometimes throw you a “curve ball.” Without warning, a disability or untimely death can cause financial hardship for your family. Adequate insurance is an important foundation for your financial plan—it offers the protection you need to help cover potential risks and liabilities.
  • Consult your financial professional. In today’s complex financial world, everyone needs help making informed decisions. Planning can help ensure that your financial affairs are consistent with your current needs and long-term goals.

A financial review can help bring focus to your overall financial picture. In the future, you will have the opportunity to alter your plans due to changing goals and circumstances. By faithfully tracking your progress with periodic reviews, you will be in a better position to build financial security and realize the retirement of your dreams.

The information provided is not written or intended as tax or legal advice and may not be relied on for purposes of avoiding any Federal tax penalties. Entities or persons distributing this information are not authorized to give tax or legal advice. Individuals are encouraged to seek advice from their own tax or legal counsel.
The information contained in this newsletter is for general use and it is not intended to cover all aspects of a particular matter. While we believe all information to be reliable and accurate, it is important to remember individual situations may be entirely different. Therefore, information should be relied upon only when coordinated with professional tax and financial advice. The publisher is not engaged in rendering legal, accounting, or financial advice. Neither the information presented nor any opinion expressed constitutes a representation by us or a solicitation of the purchase or sale of any securities. This newsletter is published by Liberty Publishing, Inc., Beverly, MA, COPYRIGHT 2007.