One more way to save on taxes (and help a child in the process) …

Okay, we’re really getting down to the wire now, with just one week left to file your taxes on time.

This year you actually have until April 17th because the 15th falls on a Sunday and the 16th is Emancipation Day, a holiday that is celebrated in Washington, D.C. But still, we’re talking a matter of days left.

And yet I have one more way for you to keep additional money away from Uncle Sam while helping a kid in your life.

It’s called a Coverdell ESA, and it shares a lot in common with some of the other tax shelters I’ve been telling you about in recent columns. Only this type of account is expressly designed to help fund a child’s education.

I’ve been using a Coverdell for my own daughter ever since she was born five years ago … and I made my latest contribution last week for the 2011 tax year.

Yes, That’s Right — You Can Still Fund
a Coverdell ESA and Have It Count for 2011!

Coverdell Education Savings Accounts used to be known simply as Education IRAs, and while they’re not really “retirement” accounts, they DO function very much like Roth IRAs designed for young students.

In fact, like Roth IRAs, they allow you to sock away money — $2,000 a year, in this case — by tax day.

And like Roth IRAs, as long as the funds are used for the benefit of schooling costs, any returns earned in the account will be distributed free of additional taxation going forward.

While that’s not an eye-popping number, it’s still a nice chunk of change that will add up over the years.

Plus, it’s perfect for using any tax refund money you might have already received if you happened to file your taxes earlier than procrastinators like me.

Meanwhile, don’t underestimate the benefit of that tax shelter!

Heck, let’s say you happened to put $2,000 into your child’s Coverdell account and invested it so wisely that within ten years it had miraculously turned into $200,000. That full amount would be available to pay for your kid’s education, and not one penny of taxes would need to be paid as you pulled it out!

Another cool feature of Coverdell accounts is that — unlike ever-popular 529 Plans — they can be used for expenses related to ALL types of schooling: High-priced pre-K classes, private secondary education, and even many associated costs such as computers and books.

Originally both this feature — and the $2,000 annual contribution limit — were going to change. But last year’s tax package kept both items intact through 2012 … which is great news.

And While There ARE Income Restrictions …
Here’s a Cool “Trick” That Lets You Avoid Them!

Like the Roth IRA there are some caps to be aware of: Technically, you cannot fund a Coverdell if you have MAGI above $110,000 filing singly or $190,000 married filing jointly. Phase-outs kick in at lower levels, too.

But here’s where it gets interesting — even a child with no earned income can contribute to a Coverdell!

So if you’re above the income threshold, you can just gift the $2,000 to the child under the Uniform Transfer to Minors Act and they can put it in the Coverdell themselves.

Yes, it’s a stupid formality, but if it works in your favor, go with it!

And again, please note that you can establish a Coverdell for ANY child in your life — not just a direct relative but even a friend’s child or grandchild. Corporations and trusts are also free to establish Coverdells.

Just know that a Coverdell’s beneficiary can only have $2,000 contributed to his or her account in any given year. So you should always ask whether an account already exists and how much has been deposited before establishing one on your own. Contributions must also be made before the beneficiary turns 18.

Also, a Coverdell beneficiary has to use the funds before turning age 30, or else taxes and penalties will likely be owed. However, the account can always be switched to another beneficiary before then — even if the new recipient is between ages 18 and 30!

Bottom line: You don’t get the potential for up-front tax deductions that you do with 529 plans, but Coverdells are a unique way to sock away a little extra money for someone special.

Plus, they can be fully funded in addition to 529 plans. So if you’re an aggressive saver and planner, they are definitely worth investigating.

If you’re interested in establishing a Coverdell, just check with your regular brokerage house or other financial institution. Most offer them, and it’s just a matter of completing some simple paperwork. But remember, you only have a week left to open one for the 2011 tax year!

Best wishes,

Nilus

P.S. While I’m using a Coverdell ESA for my daughter, I’m using regular IRA accounts for myself and other close family members. In fact, this special online presentation explains exactly what I’m doing in my father’s account right now.