In my previous post, I have looked into Coverdell Education Savings Account and checked if it can be used by homeschoolers to pay for homeschooling expenses. The good thing it can be used as a savings vehicle and probably is the only viable option for homeschoolers. However, there is one catch. In order to qualify for the Coverdell, your state must treat homeschool as a private school. Unfortunately, at this moment not every state does that (in fact, only 14 out of 50 states treat homeschool as a private school), meaning that not every family can use it.
Anyways, even if your state does not allow to withdraw money to pay for your homeschool expenses, there are still a lot of ways to benefit from opening a Coverdell ESA. The most important one is that money grows tax-free and can be invested in almost any investment vehicle out there, including individual stocks, options, ETFs, mutual funds. The other important feature of the Coverdell is that it can be used not only for elementary and middle school expenses, but for college and personal education, too. Taking into account only these few factors, I highly encourage you to consider opening a Coverdell ESA as a tool for paying off your kids future education expenses.
How to open a Coverdell ESA?
Opening a Coverdell ESA is pretty similar to opening any other investment account, meaning it is usually done online by filling out a form. However, the challenge is to find a decent, low-cost provider. Not many financial institutions want to bother themselves with the Coverdell mostly due to low contribution limits and low profit potential. Those who do offer it usually charge high fees or have some other constraints. And this is something you should always keep in my mind.
You can open an account with any financial institution or custodian, like a bank, broker, or investment company. By opening an account with a bank, you basically deposit your money in a savings account where they grow risk-free until you withdrawing your money. However, under current low-interest rate environment pursuing this option does not provide you with any significant benefits. It will take you a decade to see a notable increase. As an alternative, you are better off by opening an account with a broker so you can get an access to a broader range of investment vehicles and create an investment portfolio aligned with you investment horizon and risk/return preferences.
Below you will find my list of best Coverdell ESA providers. In order to include a provider in the list, I looked at the following:
- Account minimum – $0, meaning you can start right away.
- Annual maintenance fees – $0, so you avoid paid high annual fees just for having the account.
- Transaction costs – since you will be contributing on a regular basis, you will need to invest your deposits and reinvest dividends. Paying too much in brokerage fees may significantly affect your investment return. My criteria were to find a provider that offers a wide variety of commission-free ETFs and/or has transaction costs as low as possible.
My Top Four Coverdell ESA Providers
- TD Ameritrade. TD Ameritrade is a well-known brokerage company that gives access to both individual stocks and exchange-traded funds. In general, its trading fees are very expensive, $9.99 per trade. However, my reason to include TDA in the list is that TDA offers a wide range of commission-free ETFs. 100 to be exact. The list of their ETFs allows investor to choose not only from domestic stocks and bonds, but also gain some exposure to international stocks and commodities. If you have your own model portfolio or work with an adviser who specializes in index funds then TDA may be a good option.
- TradeKing – is probably the cheapest online discount broker I was able to find that offers Coverdell ESA. For a flat $4.95 you will be able to trade individual stocks or ETFs of your choice.
- Capital One Sharebuilder – when Capital One bought ING Direct and ShareBuilder in 2012, I expected nothing good from the deal, especially fee-wise. Luckily, I was wrong. The company continued to provide excellent customer services, with not so high transaction costs as other big companies. Right now, you can trade for $6.95 per trade with no account minimums and maintenance fee.
- Firstrade – is not a broadly known online broker, but the one that offers competitive pricing. Right now it is $6.95 per trade with zero maintenance fee and account minimum.
If you look at the presented above options you may conclude that there is not a lot to choose from. And you will be absolutely correct. Even though there are some other brokerage companies on the market that you can choose from, I did not include them in the list because they either offer higher transaction fees or offer a poorer choice of commission-free ETFs.
I Choose TD Ameritrade
Whatever Coverdell ESA provider you decide to choose, you need to pay serious attention to trading costs, as they are one of the biggest threat towards accumulating enough funds to pay for your child’s education. Considering $2,000 annual contribution limit, actively trading on your account when you just start building your Coverdell ESA is definitely not an option. Trading fees will easily and quickly eat up all your potential profit or even worse, they may even dip into your principal. Moreover, even taking into account consistent $2,000 annual contribution for a total of $36,000 over the next 18 years (the age you are required by law to stop making further contributions), you will still may experience what a burden high transaction fees can be.
Having said that, I think that the best option with the Coverdell ESA is opening up an account with TD Ameritrade and creating a well-diversified index portfolio of commission-free ETFs, performing rebalancing on a regular basis, and reinvesting dividends along the way.