Coverdell Educational Savings Account (ESA)

Coverdell Educational Savings Account (ESA), formerly known as an Education IRA, is a college savings account with tax benefits. Learn how you can open one.
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College tuition is expensive and it’s not getting any cheaper. Thankfully there are a few programs out there that make it easier to save for college. This is especially important if you if you are saving for your child’s tuition and will not be able to use your GI Bill benefits to help pay for your child’s college. Yesterday, we looked at the 529 College Savings Plan, which is a great way to save for college tuition. Today we will look at another college savings plan that offers tax benefits.

Coverdell Educational Savings Account (ESA)

Once called an Education IRA, a Coverdell Educational Savings Account (ESA) is named after Senator Paul Coverdell, who introduced this college savings plan. Coverdell ESAs are similar to IRAs, but they are designed to save money for education rather than retirement. Because of this, the name was changed from Education IRA to Coverdell ESA, to more accurately reflect what the money is being saved for.

How the Coverdell ESA Works

A Coverdell ESA is a savings or investment account for college tuition. You can open an account through a mutual fund company, bank or brokerage firm, choose the investments and then send in contributions. The person who opens the account is considered the “responsible person” and controls the money and investments until the beneficiary reaches the age of majority for the state in which they live in. For most states, this is the age of 18.

Contribution limits. Annual contribution limitations for Coverdell ESAs are $2,000 per student. However, contribution limits may be limited based on the modified adjusted gross income (MAGI) of the person making the contributions. Here is additional information about contributions:

  • Anyone can contribute up to $2,000 in a Coverdell ESA for the benefit of someone under the age of 18, unless you exceed income limitations. For single tax filers, if you make more than $110,000 annually, you will not be able to personally contribute to a Coverdell ESA. For joint tax filers, you must make less than $220,000 per year to contribute.
  • There is also a phase-out income range that allows for lower contribution amounts. This is based on a MAGI for single filers of between $95,000 and $110,000, or income between $190,000 and $220,000 for joint filers.
  • If you exceed the income limitations for contributing to a Coverdell ESA, you can give the money as a gift to the student beneficiary, who can then contribute or open the ESA themselves.

Tax Benefits of Coverdell ESAs

Coverdell ESA contributions are not tax deductible, but earnings and withdrawals from a Coverdell ESA are tax free, as long as distributions from the Coverdell are made for qualified educational expenses. Qualified expenses include college costs but can also extend to private schools at the elementary or secondary school levels, uniforms, computers and transportation for education purposes.

If a beneficiary of a Coverdell ESA uses the money for anything other than qualified education expenses, they are subject to a 10% penalty, and the money is treated as ordinary income at tax time. Money in Coverdell ESAs must be used by the time the beneficiary is 30 years old, whether it is for qualified educational expenses, non-qualified expenses and assessed a 10% penalty or transferred to a relative.

How to Choose a Coverdell ESA

Just like any other investment, the Coverdell ESA can be opened through brokerage firms, banks or mutual fund companies. You’ll want to compare fee structures and commissions when making your selection, as well as the types of investments to include. Here is additional information on where to open a Coverdell ESA Plan.

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