Like the 529 Plans, the Coverdell Education Savings Account (ESA) is a tax-advantaged college savings plan. Once known as the Education IRA, the Coverdell ESA works very much like the Roth IRA: Your contributions to an investment account are non-deductible but your earnings grow tax-free. Withdrawals are also tax-free when used for qualified higher education expenses.
Frequently Asked Questions about the ESA
>> How much can I save in an ESA?
>> What are considered eligible education expenses?
>> What if my child chooses not to attend college?
>> Can I withdraw the funds for non-educational expenses?
>> Where can I invest my Coverdell ESA savings?
>> Can I contribute to both an ESA and a 529 Plan?
>> Who owns the ESA? Me or my child?
>> How will ESA savings affect my child’s financial aid award?
How much can I save?
You can save a total of $2,000 per year per minor child in a Coverdell ESA. Once your child reaches the age of 18, you can no longer make contributions to the account.
If grandparents or friends want to contribute to the fund or set up their own fund, they may — but the net total of all contributions per beneficiary may not exceed $2,000 annually.
Additionally, the amount of allowable contributions begins to phase out after you reach a certain income level. In order to make the full $2,000 contribution, you must have an Adjusted Gross Income (AGI) of less than $95,000 for single filers and $190,000 for joint filers.
If you earn between $95,000 – $110,000 as a single filer or $190,000 – $220,000 as joint filers, your total allowable contribution is reduced relative to your income. Those earning more than $110,000 as a single filer and $220,000 as a joint filer may not contribute to the Coverdell ESA.
What are considered eligible education expenses?
Unlike the 529 Plans, which may only be used for higher education expenses, the Coverdell ESA may be used to cover any education expense from kindergarten through your child’s PhD. Congress is set to extend this benefit in 2010, so if you plan to use your Coverdell ESA to cover tuition at elementary school, be sure to stay on top of that authorization.
What if my child chooses not to attend college?
If you don’t use your ESA for elementary or secondary education costs, and your child decides not to attend college, you can transfer the beneficiary on the account to another child in your family.
Also, keep in mind that ESA funds can be used up until the beneficiary reaches the age of 30. So even if your child starts school a bit later than age 18, he or she is still eligible to use the money you saved. If by the age of 30, the beneficiary has not fully withdrawn the funds, the account must be transferred to someone else (who is not yet 30).
My parents set up an ESA for me. Can I withdraw the funds after the age of 30 and use them for non-educational expenses, like for a down payment on a home?
The short answer is no. Unlike the 529 Plans, which allow you to withdraw the funds for non-approved expenses (after being assessed a hefty penalty), you do not have that option with a Coverdell ESA.
Where can I invest my Coverdell ESA savings?
You can open a Coverdell ESA at any financial institutions that can serve as a custodian for a traditional IRA. Savings may be invested in stocks, mutual funds, CDs or bonds — or any combination thereof.
Keep in mind that since your allowable annual contribution is fairly small, maintenance fees will take a relatively big bite out of your growth. Look for no-load plans and carefully compare fee structures.
Can I contribute to both an ESA and a 529 Plan?
Yes, absolutely. In fact, many families contribute the maximum amount to their ESA and then top off their college savings with additional contributions to a 529 Plan.
Who owns the ESA? Me or my child?
While your child is the beneficiary of the Coverdell ESA, you are the owner of the account. Although you must use the funds to cover your child’s educational expenses, your kiddo does not get control of the fund at any point.
How will ESA savings affect my child’s financial aid award?
Like a 529 Plan, your ESA account is considered an asset of the custodian, which, in most cases, is the parent. According to FAFSA calculations, parental assets are assessed at a lower rate than student’s assets, so the overall reduction in financial aid will be minimized.