A Roth IRA, or individual retirement account, and a Coverdell Education Savings Account, or ESA, are two different beasts. Though both allow you to grow your money tax-free and pay for educational expenses, their main purposes are different. The ESA is only for educational expenses, and the IRA is mainly meant for retirement. Still, because you can use both to pay for your education or that of your child, it's helpful to determine which is best for you.
Both types of accounts require you to contribute taxed dollars to the fund. When you withdraw the money from an ESA, you do not have to pay taxes on the money as long as you use it for qualified educational expenses, including tuition, supplies, required books and room and board. When you withdraw from a Roth IRA, any contributed amounts are non-taxable, but earnings are taxable if they are less than 5 years old. If you use the earnings for educational expenses that are not qualified, you will have to pay a 10 percent penalty in addition to any taxes due.
Type of Education
The ESA allows you to spend the money on any type of education, including elementary, secondary and higher. Private, religious and public schools are eligible as long as they are accredited by the Department of Education. Funds in a Roth IRA are eligible only for higher education expenses.
The funds in your ESA are eligible only for qualified educational expenses. On the other hand, the funds in a Roth IRA may be spent on a variety of things, including living through retirement, purchasing a first home, paying health, costs and covering you in the case of disability. If your child is attending public school, the Roth IRA is a clear choice when it comes to investing your money, because it allows you to wait to see what type of financial aid package your child receives before dipping into your savings.
It's important to keep careful track of your spending whether you're using an ESA or an IRA for educational expenses. If you simply give your child $400 for books, she might only spend $300 on books and $100 on going out or items for her dorm room -- items that would not fall under allowable expenses. The smart thing to do is to estimate exactly how much money you'll need for expenses, withdraw only that amount, and keep it in a separate bank account from which you make all educational purchases.
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