Investment Company and Variable Contracts Products Representative (Series 6)Practice Exam

In a Coverdell Education Savings Plan, what type of contribution is allowed?

1. Pre-tax contribution

2. After-tax contribution

3. Tax-free withdrawal

4. Employer contribution

The correct answer is: After-tax contribution

In a Coverdell Education Savings Plan, the contributions made are after-tax contributions. This means that the money is deposited into the account after income taxes have been paid. The benefit of this arrangement is that the money in the account can grow tax-free, and qualified withdrawals for educational expenses are also tax-free. This structure encourages saving for education without incurring tax liabilities on growth or withdrawals as long as the funds are used for eligible educational expenses. The significance of using after-tax contributions is that it allows for flexibility with respect to tax obligations upon withdrawal, which can be particularly valuable for families planning for future education costs. When the funds are eventually used for qualifying expenses, they are not subject to further taxation, thus maximizing the benefit of the saved funds. In contrast, pre-tax contributions, which are not allowed in a Coverdell account, would mean that contributions would be tax-deductible in the year they are made, but this type of treatment is more typically associated with accounts like traditional IRAs or 401(k)s. Employer contributions are also not permissible within the Coverdell framework. Lastly, while tax-free withdrawals are a feature of the account, they relate to distributions rather than contributions, distinguishing them from the actual contributions that are made to