How Coverdell ESAs work today
While not as popular as state-run 529 plans for education savings, Coverdell ESAs do enjoy some unique benefits in addition to the tax-advantaged features they have in common. Characteristics of a Coverdell ESA include:

• Income taxes on invested assets are deferred until withdrawal.
   
• Withdrawals used for qualified educational expenses are tax-free.
   
• Tuition, books, room, board and other costs associated with higher education (including computers, software and Internet connections) are considered qualified expenses.
   
• Coverdell ESAs can be used to fund elementary and secondary education. (529 plans allow only higher education costs.)
   
• Investment options for Coverdell ESAs are generally less restrictive than those offered by most 529 plans.
   
• Individuals and married couples can contribute up to $2,000 per child annually to a Coverdell ESA, depending on their income. (529 plans do not have income restrictions.)
   
• The custodian of a Coverdell ESA can designate a new beneficiary without incurring taxes or penalties, provided the new beneficiary is an eligible family member of the previous beneficiary.

What is likely to change
Unless Congress extends the provisions established in 2001 before the end of the year, Coverdell ESAs will look very different and less appealing to many investors:

• Withdrawals for kindergarten through 12th grade will no longer be considered qualified expenses.
   
• Maximum annual contributions per beneficiary will be reduced from $2,000 to $500.
   
• Contributions to both a Coverdell ESA and 529 plan for the same beneficiary in same year will not be allowed.
   
• Claiming Hope and Lifetime Learning Credits will not be permitted in the same year as a Coverdell distribution for qualified educational expenses.

Your options before the end of the year
Assuming that Congress won’t get around to extending the special provisions for Coverdell ESAs, there are a number of strategies you could pursue:

• Roll your Coverdell ESA into a 529 plan. Congress has already made the tax provisions extended to 529 plans in 2001 permanent, meaning they will carry far fewer restrictions and limitations in 2011. And, if you follow the appropriate steps, prior to 12/31/2010, there will be no tax consequences from the rollover.
• Spend down the balance in your Coverdell ESA before year end. Depending on how much is in the account now, you could have all of the first semester of the 2010-2011 school year to deplete the funds. But be sure to spend the withdrawals on qualified education expenses¹ to avoid taxes and penalties.
• Maintain your Coverdell ESA. While several of the key tax advantages are likely to disappear, the flexibility in investment types and styles permitted may be attractive to you, depending on how long you have before your child reaches college and needs to start making withdrawals.

If you own a Coverdell ESA, we encourage you to speak with your Financial Advisor soon about your current education savings plans and determine whether they are the best fit for you and your goals, especially in light of what looks to be a major change looming for Coverdell ESAs.

¹You can find a detailed list of qualified expenses at fairmark.com/college/saving/coverdell/tax-free.htm

Investors should consider the investment objectives, risks, charges and expenses associated with a 529 plan before investing. This and other information is available in a plan’s official statement. The official statement should be read carefully before investing.

Depending on your state of residence, there may be an in-state plan that provides tax and other benefits not available through an out-of-state plan. Before investing in any state’s 529 plan, you should consult your tax advisor.

This information is not provided as tax advice, but for information purposes only. Please consult with your tax advisor.