A Coverdell Education Savings Account (Coverdell ESA), formerly known as the Education IRA, is a tax-advantaged education savings account that lets you save money for college, as well as for elementary and secondary schools (K-12) at public, private, or religious schools. Coverdell accounts are created exclusively for the purpose of paying the qualified education expenses of the designated beneficiary of the trust. Your earnings and any capital gains accumulate tax deferred, and withdrawals are tax-free if they are not greater than the beneficiary’s qualified education expenses.
Coverdell ESA Rules:
- They can be opened for any student who is under the age of 18 years.
- There is no limit on the number of separate Coverdell ESAs that can be established for a designated beneficiary.
- Total annual contributions cannot be more than $2,000, no matter how many accounts have been established.
- They can be started at participating banks, mutual fund companies, and other financial institutions.
- Account owners can choose the investments, which can include stocks, bonds, mutual funds, or certificates of deposit and have sole control over the investments.
- The assets must be withdrawn within 30 days after the date the designated beneficiary turns age 30. Accounts for beneficiaries with special needs generally are not subject to the age restrictions on contributions and withdrawals.
- You can open both a Coverdell ESA and a 529 plan for the same beneficiary and contribute to both types of plans in the same year for the same beneficiary. You can withdraw funds from a Coverdell ESA & 529 plan in the same year for the same beneficiary.
Contributions:
Contributions over the $2,000 annual limit will be subject to a 6% tax penalty. The contributions are nondeductible and must be made in cash. You can contribute up until April 15 of the year following the tax year for which the contribution is being made. There are income limits the federal government has in place that will determine if you are eligible to contribute to a Coverdell ESA. To make a full contribution (based on the income of the contributor), single filers must have a modified adjusted gross income (MAGI) of less than $110,000, and joint filers must have a MAGI of less than $220,000. A way around this limit is to have your beneficiary, who has income below the allowable limit, make the contribution by gifting the money to the beneficiary first. There is no requirement that the contributor have earned income as there is for Traditional and Roth IRAs. Organizations, such as corporations and trusts can contribute regardless of their adjusted gross income.
Distributions:
Distributions are tax-free if they are not greater than the beneficiary’s qualified education expenses. If distributions are withdrawn for non-qualified education expenses, then the earnings portion of that excess is subject to income tax and an additional 10% penalty tax.
Any balance in the account must be distributed within 30 days of the beneficiary turning 30. If there is a remaining balance after this point, then the earnings portion of that remaining balance is subject to income tax and an additional 10% penalty tax.
Qualified education expenses include the following:
Elementary and secondary education: Tuition, fees, academic tutoring, books, supplies, equipment related to enrollment, uniforms, extended-day programs, transportation (if you are charged for mandatory school bus transportation), and room and board if required or offered by school.
College expenses: Tuition, fees, books, supplies and equipment. For college students who carry at least half the normal workload according to standards used by the college to determine full-time status, payments for room and board can be qualified education expenses.
Rollovers and transfers:
Rollovers and transfers are both possible with a Coverdell ESA. A rollover is a tax-free distribution from a Coverdell account that is paid into another Coverdell account within 60 days of the distribution. The receiving account must have the same beneficiary or a beneficiary who is a family member of the distributing account’s beneficiary. The receiving account’s beneficiary must also be less than 30 years old, unless he/she is a special needs beneficiary. An eligible family member can be the beneficiary’s spouse, sibling, niece, nephew, parent, aunt, uncle, child, grandchild, in-law, or first cousin. The spouse of any of these relations (except for a cousin) is also a qualifying family member. Keep in mind that only one rollover per Coverdell ESA is allowed during the 12-month period from the date of the distribution.
Carol Chaudet
(last update 10/29/15)