A Guide to Coverdell ESAs
Written by James Chan   

This article is ideal for parents who want to find a way to save money for their child’s private education including college, private schooling, and other educational expenses.


What is a Coverdell Education Savings Account?

The Coverdell Educational Savings Account (ESA), named the Education IRA before 2002, aids parents and students save for education expenses by allowing them to create accounts in which cash contributions made are non-deductible and grow tax free. 

The beneficiary, usually a son or daughter, can make tax free withdrawals from the money in the accounts for their elementary, secondary or post-secondary education. Qualified education expenses include:
  • Tuition and fees
  • Books, supplies, and equipment
  • Room and board for students who are enrolled at least half-time
Tip: Computer technology, equipment, or Internet access is a qualified elementary and secondary education expense if it is to be used by the beneficiary and the beneficiary's family during that time.
 

How do Coverdell ESA’s work?

Similarly to Roth IRAs, Coverdell ESAs work by making an annual contribution of up to $2,000 to a managed investment account. Your cash contributions can be invested using a variety of strategies and in a variety of markets similarly to a 529 plan. The deposit and interest accumulated, as well as any education-related withdrawals, are tax-free. However, a 10% penalty and additional federal and state taxes apply if you withdraw for any other reason.
 
 
Creating and Managing a Coverdell ESA

To be eligible to contribute to a Coverdell ESA, your adjusted gross income must be less than $110,000 if you are filing as an individual, and $220,000 if you are a couple filing jointly. 

  Partial contribution Full Contribution No Contribution Allowed
Single $95,000-$110,000 $95,000 or less $110,000 or more
Joint $190,000-$220,000 $190,000 or less $220,000 or more
 
If you are eligible for a Coverdell ESA, you can go to any bank, mutual fund, or other financial institution that offers it and set one up. Here are some places.

Although there are no limits to how many separate Coverdell accounts can be created for your child, the total of all contributions to a single child cannot exceed $2,000 per tax year. Contributions must be in cash.

Withdrawals must be for the benefit for the child and not refunded to the establisher of the ESA. One important thing to keep in mind: once the beneficiary turns 30, all contributions to the fund are refunded to him or her, minus a 10% penalty tax and any applicable federal or state withdrawal taxes. You can change the beneficiary of the ESA at any time provided that the new beneficiary is under 30 years old.


Advantages and Disadvantages

Advantages
  • Deposits and interest accumulated are tax-free.
  • Coverdell ESAs allow a wider range of investment options than 529 plans, and more institutions over them, providing greater variety.
  • Coverdell ESAs can be used for certain K-12 expenses- but only up to 2010 unless Congress acts to extend coverage.
Disadvantages
  • Maximum of $2,000 per beneficiary per year.
  • Cannot exist once the beneficiary reaches age 30.
  • Adjusted gross income limits for creation and contribution.
  • Can be used without penalties only for educational purposes.
  • Account maintenance fees.
 


 
Last Updated on Tuesday, 21 December 2010 04:45