What is a Coverdell ESA?
A Coverdell Education Savings Account (Coverdell ESA or, simply, ESA) is a tax-advantaged savings account created to encourage saving for the future cost of an elementary, high school and college education.
Tax Benefits of a Coverdell ESA
Contributions are not tax deductible. As with 529 Plans, investment earnings within the account grow tax-free and qualified distributions made to qualifying educational institutions are also made tax-free.
Investment Options within a Coverdell ESA Account
ESAs can allow almost any investment within the account including stocks, bonds, and mutual funds, while 529 plans usually allow only a choice among a number of state run allocation programs. The rules for investments allowed in ESAs are the same as those for Traditional IRAs.
Who Qualifies as the Student Beneficiary?
The student, or “designated beneficiary”, of the Coverdell ESA must be under the age of 18 when the account is established. Exceptions are made for those who meet “special needs” requirements.
Where can a Coverdell ESA be Established?
Unlike the 529 Plans, which vary from state to state, the Coverdell ESA is a federally defined program and can be opened anywhere in the United States, usually with a bank or an IRS-approved entity that offers Coverdell ESAs.
Can More Than One ESA be Established for the Same Person?
Yes. There is no limit to the number of separate ESAs that can be created for the same person. Where limits apply and can become confusing, are that total contributions for the beneficiary across all accounts and made by all contributors across these accounts, cannot exceed $2,000 per year.
Contributor Limits
In addition to the $2,000 annual contribution limit for the beneficiary of an ESA, there are annual contribution limits that apply to the contributors. Generally, a contributor may contribute up to $2,000 per beneficiary per year. This limit applies regardless of how many ESAs a beneficiary may have. Note that a contributor may contribute up to the limit of $2,000 for more than one beneficiary per year.
Who Can Contribution to a Coverdell ESA?
Any individual, including the beneficiary of the ESA, can contribute to the account as long as that person has a Modified Adjusted Gross Income (MAGI) less than $110,000 if filing individually, or $220,000 if filing a joint tax return. Organizations, such as corporations and trusts, can also contribute to Coverdell ESAs. There is no requirement that an organization’s income be below a certain level. Note that there is a gradual reduction in the contribution limit when the contributor’s MAGI is between $95,000 and $110,000 (or between $190,000 and $220,000 when filing jointly).
Other Contribution Requirements
Contributions are required to be made in cash. Contributions must be made before the beneficiary reaches the age of 18 (except for special needs students). Money in the account cannot be invested in Life Insurance contracts.
Contributions must be made by the due date of the contributor’s tax return (not including extensions). Contributions made to a Coverdell ESA for the preceding tax year are considered to have been made on the last day of the preceding year.
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What Educational Institutions are Eligible?
Elementary and Secondary School – Eligible are any public or private schools that provide elementary or secondary education (kindergarten through grade 12), as determined under state law.
Post-Secondary Schools – Eligible are any college, university, vocational school, or other post-secondary institution eligible to participate in a student aid program administered by the U.S. Department of Education. This includes virtually all accredited public, private and nonprofit postsecondary institutions. The educational institution should be able to tell you if it is eligible to receive ESA funds.
What Education Expenses does the ESA Cover?
Qualified Elementary and Secondary Education Expenses:
- Tuition and fees.
- Books, supplies, and equipment.
- Academic tutoring.
- Special needs services for a special needs beneficiary.
The following expenses must be required or provided by an eligible elementary or secondary school in connection with attendance or enrollment at the school.
- Room and board.
- Uniforms.
- Transportation.
- Supplementary items and services (including extended day programs).
Qualified Higher Education (i.e. colleges and universities) Expenses:
- Tuition and fees.
- Books, supplies, and equipment.
- Room and Board for half-time or greater enrollment (the amount varies depending on whether or not the housing is owned and operated by the school).
Age Limit for Attending School
Unlike the 529 Plan, which allows adults of any age to attend school and receive qualifying benefits, balances in Coverdell ESA accounts must be distributed for qualified educational expenses before the beneficiary reaches 30 years of age. In order to avoid taxes and penalties on unused funds, a new beneficiary can be named to the account provided that the new beneficiary is an eligible family member of the previous beneficiary.
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The Differences Between a 529 Plan and Coverdell ESA
Todd E. Frank, CPA/PFS, MBA is the President and CEO of Frank Financial Advisors, a Registered Investment Advisory Firm (RIA) serving clients nationwide from our headquarters in Carlsbad, San Diego, California. As an RIA, Frank Financial Advisors is able to offer truly independent, fee-only financial advisory services.
