Backdoor Coverdell ESA Tutorial

I’ve written about Education Savings Accounts (ESAs) before. But what about the new tax laws? Use this guide to learn everything you need to know to get started with a backdoor Coverdell ESA.

First things first. With the new tax law allowing one to withdraw $10,000 annually towards private school, you may think the ESA is no longer needed. Not so fast.

The ESA still makes sense to contribute to even if you’re not sure if your child will attend private school. It becomes a 529 if he doesn’t. Ideally, you would open both a Coverdell ESA and a 529 as soon as your child is born (or better yet, open the 529 before they are born).

If you plan to send your child to private school, then ideally you would frontload the 529 x 5 years or $150,000 ($30,000 x 5 years) to give the magic of compound interest a head start.

Still, that only gives you about 5 years if you send your child to private kindergarten. It’s best if you give it more time to grow if you plan to use part of the 529 for private school.

Meanwhile the ESA account is growing (yes, it is limited to only $2,000 a year), but by the time Junior is in middle school or high school, the ESA account will have around $40,000 in it.

Using the 529 for private school is even more attractive when you have a state income tax deduction and you continue to contribute to it as you withdraw annually for private school.

Most private schools in the U.S. are well over $10,000 a year, so the ESA functions as a backup reserve of tax advantaged funds to use.

Backdoor Coverdell ESA Steps

Now, how do you actually open and fund a backdoor Coverdell ESA? Most physicians are well over the income limit. There are 3 basic steps:

Step 1: Open a UTMA account and fund it.

My suggested custodians for this account are etrade, TD Ameritrade, and Charles Schwab. None of these custodians charge a fee and many of you likely have an account already at one of them. You fund the UTMA with gifted money, so this goes towards the annual gift limit ($15,000 in 2018). Note, the gift does not need to come from you.

Step 2: Open a Coverdell ESA account.

Again, I recommend the same three custodians above. And I recommend you use the same custodian for both accounts for ease.

Step 3: Transfer money from the UTMA into the Coverdell ESA.

This is the “backdoor” way to fund the ESA since the UTMA is owned by your child.

Final Thoughts on Backdoor Coverdell ESAs

We chose TD Ameritrade for our UTMA and Coverdell ESA. Right now, we don’t have a plan as to how much we will fund the UTMA in general and are mainly using it to contribute to the ESA.

We also don’t know if we will choose public or private school yet. Eggy was born in late 2017, and we have funded both 2017 and 2018. You have until tax day to fund the ESA.

To give your savings a head start and to let compounding do some of the heavy lifting, get started with the first step of a backdoor Coverdell ESA today.

What do you think? Do you plan to open an ESA for your child?

4 Comments

  1. Kirk Pak on November 6, 2018 at 11:00 pm

    Are there any resource/website or references that you could cite that could confirm the legality of this process? I am in the process of trying to do this at E*Trade, but am getting a lot of questions about it? Thanks!



    • Miss Bonnie MD on November 7, 2018 at 10:02 am

      It is definitely legal. I would just ask etrade how to transfer money from the UTMA/UGMA to the ESA.



  2. Laura P. on January 7, 2019 at 4:07 pm

    So, to clarify, you are saying that when the UTMA is opened, the owner is the child, or some other family member?



    • Miss Bonnie MD on January 7, 2019 at 4:16 pm

      UTMA is a custodial account – so under the control of whoever opens it (usually a parent) and becomes the child’s legally at the state’s age of majority, age 18-21.



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