A child’s education is one of a parent’s biggest expenses. The priciest college is now over $75,000 a year! Room and board costs are increasing every year… It’s never too early to start thinking about how to earn and save money, to not have the financial stress as children get older. There are several ways to begin planning for the expenses you will incur in the years ahead.
One of the most common savings plans for education is the 529 plan. There are two types of 529 plans: college savings plans and prepaid tuition plans. Almost every state has at least one 529 plan. There is also a 529 plan operated by a group of private colleges and universities. A 529 plan is a tax-advantaged savings account designed to be used for the beneficiary’s education expenses.
Aside from the 529 plans, real estate investments are excellent leverage that allow you to start out with a relatively small investment and end with a large return. One of the smartest ways to begin the process of saving is through a Coverdell Education Savings Account (CESA). The CESA is a fund that can be used to invest in real estate and grow tax-free.
Benefits of Coverdell Education Savings Account (CESA):
- Money is invested using after tax dollars, allowing the account to grow tax-free.
- Unlike a 529 Plan, your investment in CESA can be used to cover education expenses from kindergarten through college until the beneficiary turns 30 years old.
- Funds can be withdrawn any time after the account is set up.
- You can invest in a CESA with any Roth IRA custodian.
- CESA does not limit you on real estate and can be used on other investments such as mutual funds, stocks and bonds.
- Investing in a CESA will not reduce your child’s chance of receiving financial aid, as only 5.64% of the value will be factored into the student’s expected family contribution on the FAFSA (Free Application for Federal Student Aid).
Limitations of Coverdell Education Savings Account (CESA):
- The maximum contribution for one child is $2,000 per year.
- There are income limitations if you have an adjusted gross income of $110,000 or $220,000, if filing jointly.
- To avoid a 10% penalty the funds must be used by the time the child reaches age 30, however, you can transfer the funds to another child who is younger than 30 to avoid paying the 10% penalty.
- Contributions cannot be made after the beneficiary turns 18.
- There are one-time charges that are made to the IRA custodian.
CESA Scenario Example:
Imagine a couple who has 8-year-old twins. Starting on their 8th birthday, the parents put $2,000 per year into their CESA. By age 18, each child has $20,000 in their CESA account. The parents invest the entire $40,000 in an apartment syndicated deal, which gives them a 5% equity stake in the property (determined by their dollar investment in the property). After the deal sponsor implemented the value-add strategy plan, and improved property management, the apartment increased by $2 million in two years. Through a property refinance, the deal sponsor distributes back $100,000 ($2,000,000 x 5% equity) to the parents TAX-FREE, as there are no taxes owed during refinances. Since the property did not sell the parents continue to see returns and have equity distributions at time of sale to continue paying their kid’s education expenses.
In addition to the equity pay out during refinance, the property will typically see a 6% or more annual cash on cash return, along with tenants paying down the mortgage of the property.
As you can see, real estate can be a great consideration in paying your child’s education. Making the right investment and gaining the profit needed can take tremendous stress and concern away from parents. Depending on your financial status and needs, there are different options and methods of investing. Knowing your options and seeking out the guidance from professional investors can be a life-changing experience.
Please consult your CPA/financial advisor to discuss more specifics of how you can use CESA for growing your child’s education fund.