What is a Coverdell ESA?

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If you want to save money for a child’s college education, then you may be wondering about Coverdell Education Savings Accounts (ESAs) - formerly known as Education IRAs. A Coverdell ESA is a trust or custodial account that is established for the sole purpose of paying for qualifying education expenses for a designated beneficiary. Coverdell ESAs must be designated as such at the time at which they are created.


Who is Eligible for a Coverdell ESA?

Designated beneficiaries of Coverdell ESAs must be under age eighteen when the account is established or, if over age eighteen, a special-needs beneficiary. The designated beneficiary of a Coverdell ESA may be changed at any time to a qualifying family member of the original beneficiary, provided that the new beneficiary meets the age or special-needs requirements.


Contributors to Coverdell ESAs may be individual persons or married couples, or organizations such as corporations or trusts. Individuals and married couples may not exceed Modified Adjusted Gross Income (MAGI) thresholds as specified by the IRS: $110,00 for single taxpayers (or married taxpayers filing separately) and $220,000 for married couples filing jointly. (Phase-out restrictions apply to single and married-filing-separately taxpayers earning over $95,000, and married-filing-jointly taxpayers earning above $190,000.)  Any couple or person, including the beneficiary, who does not exceed the specified MAGI limits may contribute to one or more Coverdell ESAs. Notably, organizations are permitted to contribute to Coverdell ESAs without being subject to any income restrictions.


What are Qualifying Education Expenses?

Coverdell ESAs may be utilized to pay for qualifying education expenses related to elementary, secondary, and postsecondary schooling. The IRS generally defines qualifying education expenses as those required for attendance, such as tuition and student activity fees; books, supplies, and equipment (including computers); and room and board (provided that the student is enrolled at least half-time). For elementary and secondary schooling, qualifying education expenses may also include academic tutoring, uniforms, transportation, and other supplementary items or services.


The qualifying expenses associated with attending virtually any accredited college or university, vocational school, high school, or elementary school may be funded by a Coverdell ESA.


How Can I Establish a Coverdell ESA?

Coverdell ESAs can easily be opened at any U.S. bank or other IRS-approved entity that offers Coverdell ESAs. As mentioned above, Coverdell ESAs must be designated as such at the time at which they are established. The account documentation for Coverdell ESAs must include certain IRS-required information in writing.


How Can I Contribute to a Coverdell ESA?

Individuals and couples who do not exceed the MAGI limits, and organizations of any income level, may contribute to Coverdell ESAs strictly in the form of cash. Stocks or other financial instruments may not be used to fund Coverdell ESAs. Annually, contributions must be made on or before the tax filing due date (April 15 for most taxpayers) without regard for any tax filing extensions.


How Much Can I Contribute to a Coverdell ESA?

The maximum total amount that a beneficiary may annually receive in the form of Coverdell ESA monies is $2,000. There is no limit on the number of Coverdell ESAs that a beneficiary may hold. If a beneficiary receives more than $2,000 in a year, the IRS assesses an excise tax of six percent on the excess monies received. (This excise tax can potentially be avoided by taking a distribution equivalent to the excess amount within six months of the close of the tax year.)


How are Coverdell ESA Monies Distributed?

Beneficiaries may take distributions from Coverdell ESAs at any time. At maximum, Coverdell ESAs must be fully distributed before the designated beneficiary reaches thirty years of age, unless the beneficiary has special needs. In lieu of distribution, a beneficiary may choose to transfer a Coverdell ESA to a qualifying family member.


How are Coverdell ESAs Treated for Tax Purposes?

The contributions to Coverdell ESAs are not tax-deductible. However, those contributions are permitted to grow tax-free until they are distributed. Whether the distributions are tax-free depends on whether the amount distributed in a given tax year is less than the beneficiary’s adjusted qualified education expenses. Beneficiaries may be enrolled in any number of credit-hours per semester for distributions to potentially be exempt from taxes.


Beneficiaries may receive tax-free distributions from Coverdell ESAs and claim the Lifetime Learning Tax Credit or American Opportunity Education Tax Credit in the same tax year, provided that the same education-related expenses are not claimed for more than one tax benefit.


Want More Information?

Find out how Coverdell ESAs compare with 529 College Savings Plans, from the experts at Edmit.

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