A Tax Break Expires

published 3 June 2010

If you've been using a Coverdell savings account to pay for tuition or other expenses for a student in kindergarten through 12th grade, step up your spending. Beginning next year, any earnings you withdraw will be taxable as ordinary income and subject to a 10% penalty unless used for college expenses. The maximum allowable yearly contribution to Coverdell account will also be lowered from $2,000 to $500.

Congress could step in to renew the expiring provisions, but that's unlikely.If your child will go to college, you could roll the Coverdell money into a 529 savings plan at any time, penalty-free, as long as the accounts have the same beneficiary. But if that's not an attractive option, this is the time to spend Coverdell funds creatively.

Beyond tuition and fees, you can use Coverdell money to pay for tutoring, books and supplies, uniforms, and transportation. You can buy a computer for the whole family to use and pay for Internet access, too.

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One provision that might be addressed by Congress: Starting next year, anyone who claims a higher-education tax credit cannot take a tax-free distribution from a Coverdell account in the same year, even for college expenses. Lawmakers may tweak that rule so that you can use both in the same year, but not to pay for the same expenses.

Anne Kates Smith brings Wall Street to Main Street, with decades of experience covering investments and personal finance for real people trying to navigate fast-changing markets, preserve financial security or plan for the future. She oversees the magazine's investing coverage, authors Kiplinger’s biannual stock-market outlooks and writes the "Your Mind and Your Money" column, a take on behavioral finance and how investors can get out of their own way. Smith began her journalism career as a writer and columnist for USA Today. Prior to joining Kiplinger, she was a senior editor at U.S. News & World Report and a contributing columnist for TheStreet. Smith is a graduate of St. John's College in Annapolis, Md., the third-oldest college in America.