Coverdell Education Savings Account (ESA)
What is a Coverdell Education Savings Account (ESA)?
A Coverdell Education Savings Account is a tax-deferred trust account created by the U.S. government to help families fund the education expenses of beneficiaries who must be 18 or under when the account is opened. The age restriction can be lifted for beneficiaries with special needs. Although more than one ESA can be established for a single beneficiary, the total maximum annual contribution for a single beneficiary is $ 2,000.
Key points to remember
- Coverdell funds can be used to pay for a wide variety of expenses for youth (grades K-12) attending qualifying schools.
- Coverdell funds must be used by the time the student turns 30, otherwise taxes, fees and penalties will accompany withdrawals.
- The limit for family members’ contributions to a Coverdell Education Savings Account is $ 2,000 per year.
How a Coverdell Education Savings Account (ESA) works
Formerly known as Education IRA, the ESA allows families to increase their investment income through a tax deferral as long as the funds are used for educational purposes.
For example, if you contributed $ 500 to an ESA and it appreciated to $ 5,000 in 10 years, the income would not be taxed until the account owner is enrolled in a post-secondary institution. .
When contributions are distributed, they are tax-free assuming they are less than the account holder‘s annually adjusted eligible education expenses, including tuition, books, equipment, adapted services, and even academic tutoring. Funds from the ESA account can be used for primary and secondary schools (grades K-12) as well as for higher education.
Coverdell ESAs are only available to families who fall below a designated income level.
In the event that distributions are greater than expenses, earnings are taxed at the account holder rate, rather than the contributor rate, which is usually higher.
Coverdell Education Savings Accounts Versus 529 Plans
AES can be set up in brokerage houses and other financial institutions. These accounts are comparable to another tax-free education savings plan, the 529, with a number of differences. There is no annual limit on the amount that can be deposited into a 529 plan.
In December 2019, the Setting Every Community Up for Retirement Enhancement Act (SECURE Act) extended 529 plan regulations, and now 529 plans can be used to pay off up to $ 10,000 in student loans and to pay related eligible expenses. apprenticeship programs approved by the US Department of Labor.
There is no restriction on the income level of contributors to a 529 plan. However, fees can be taken from 529 accounts and the investment can also lose money as there is no guaranteed return. on such plans. It is allowed to have a 529 plan as well as an ESA for the education costs of the same beneficiary.
Contributions made to a Coverdell ESA must be paid in cash and are not deductible. Contributions can be made by people whose adjusted gross income is within an annual limit. In addition to individuals, corporations and trusts can make unrestricted ESA contributions on adjusted gross income.
When the beneficiary turns 30, all funds remaining in the ESA must be disbursed, unlike a 529 plan. The exception to this rule is if the beneficiary qualifies as a beneficiary with special needs. It is also possible to make certain transfers from the account to members of the beneficiary’s family.