This popular savings account, formerly known as the Education IRA, is facing major changes in 2011, none of them good.

Background .....

Since 2002, this account has enabled families to invest up to $2,000 per year - in mutual funds. Although contributions are not tax deductible, withdrawals are -- provided the money is used to pay for qualified educational expenses.

You can open a Coverdell ESA at most banks, mutual fund companies and financial institutions.

One of the advantages of the Coverdell is its wide application. It can, of course, be used for college costs including tuition but it also can cover qualified elementary and secondary expenses, including fees, tuition, books, supplies, school uniforms, school transportation, tutoring, computers and extended day programs. Schools may be public, private or religious.

Another key benefit, especially if the funds are intended for college level costs, is that the money in the account can remain there until the account recipient turns 30.

It does come with three distinct disadvantages. One is that the $2,000 maximum doesn't stretch very far, given the high cost of education. Two, there are income limits on who can contribute. The $2,000 maximum is gradually phased out if your modified adjusted gross income falls between $190,000 and $220,000 (married couples filing jointly) and $95,000 and $110,000 (single filers). And, three, contributions are not tax deductible.

After December 31...

Come 2011, these unfortunate changes will kick in:

1) The annual contribution is scheduled to be reduced to a paltry $500 per year.

2) And, educational expense for primary and secondary schools will no longer be considered as a qualified expense. You can, of course, use money in the account to pay for K-12th grade expenses, but you'll be taxed on that amount.

3) You will not be able to claim the Hope Credit nor the Lifetime Learning credit in the same year that you withdraw money from your Coverdell. A state 529 Savings Plan (see below) does not have this limitation.

What you can do .....

Four steps to consider:

(1) If you were going to contribute, make your $2,000 contribution before the end of the year. Next year you'll be limited to just $500.

(2) Use the money in the account during this year - for computers, next 2011 school uniforms or tutoring. Next year's $500 won't buy much.

3) If you use the money for primary and secondary school, see if you can pre-pay next year's tuition this year, while it's still a tax-free withdrawal.

(4) Roll over the amount in your Coverdell into a state 529 Savings Plan. This way, come 2011, you won't be hit with a tax bill because withdrawals from 529s are tax-free if used for qualified expenses. (Although many college expenses are included, most 529 withdrawals do not cover tuition.)

Every state has a 529 Plan, offering a set of mutual funds (ranging from aggressive to conservative) in which to invest, similar to a 401(k).

Other benefits of a 529 plan: there are no income limitations; contributions can, in some cases, exceed $300,000 per year; and, in many states you get a tax deduction (up to a stated limit) on your state taxes for contributions to that state's plan.

Recommendation: Before taking any of the above steps, discuss your family situation with your accountant. In particular, ask how all types of college savings plans affect being granted a financial aid package.

 - Nancy Dunnan