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Cash in early on education savings account breaks

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in Small Business Tax

The Coverdell Education Savings Account (CESA), formerly the Education IRA, usually isn’t the absolute best way to quickly build a college fund for children. The annual contribution limits are relatively paltry when compared to the Section 529 plan alternative.

Strategy: Take advantage of a little-noticed tax loophole. Unlike Section 529 plans, you can take tax-free distributions from a CESA to pay for private school prior to college.  

And, if your child doesn’t need the funds, you can still use this account to supplement other higher-education savings.

Here’s the whole story: Under current law, you can contribute up to $2,000 a year to a CESA. If you have several children (or grandchildren), you can contribute up to $2,000 annually to separate CESAs set up for each one.

As an added incentive, the CESA can grow on a tax-free basis. Then you can withdraw the money tax-free to pay qualified expenses for kindergarten through 12th grade. This includes tuition and fees for attending private or religious schools, plus room and board, uniforms and transportation costs.

An individual can also withdraw CESA money tax free to pay out-of-pocket costs of attending public K-12 schools. Eligible expenses include books and supplies; academic tutoring; computers, peripheral equipment and software; and even Internet access charges.

Tip: CESA contributions phase out for higher income taxpayers. The phaseout for married joint-filing couples occurs between $190,000 of modified adjusted gross income (MAGI) and $220,000 of MAGI.

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