A Coverdell Education Savings Account (ESA) is a trust account created by the United States Government to assist families in funding educational expenses for beneficiaries. These beneficiaries must be under the age of 18 when the account is opened. Funds in a Coverdell account can be used to pay for various expenses for young students attending eligible schools. While similar to 529 plans, Coverdell funds are allowed for other school expenses to students in elementary and secondary schools.
How Does it Work?
Total maximum contributions per beneficiary in a Coverdell ESA is $2,000 a year. Coverdell ESAs are restricted to families below a certain income level based on their adjusted gross income (AGI). AGI requirements are $95,000 or below for single taxpayers and $190,000 and below for taxpayers filing as married to contribute to the $2,000 a year limit. Coverdell ESA accounts are funded with after-tax dollars and money in the account can grow tax-free.
Like a 529 plan, the Coverdell ESA allows families to increase investment earnings if the funds are used for educational purposes. Distributions from the account are tax-free provided they are less than the account holder’s annual adjusted qualified education expenses, which include tuition, books, equipment, special needs services, and academic tutoring. Funds in a Coverdell ESA can be used for higher education and secondary schools (K-12). If distributions are higher than the expenses from education, then gains are taxed at the account holder’s rate.
Coverdell ESA vs 529 Plans
It is permissible to have both a 529 plan as well as a Coverdell ESA for the same beneficiary’s educational expenses. However, with a 529 plan there is no annual contribution limit. As previously stated, there is an income restriction on opening a Coverdell ESA. With a 529, there are no income level restrictions. Also unlike the 529 plan, when a beneficiary reaches the age of 30 any remaining funds must be disbursed. There is an exception to this rule, and it is if the beneficiary of the ESA qualifies as a special needs beneficiary.
Regarding the age of the beneficiary, opening a Coverdell ESA account requires that the beneficiary is under the age of 18 and contributions can only be made until they are 18. With a 529, there is no age restriction of the beneficiary.
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This overview is for informational purposes only and is not a recommendation. It should not be the sole deciding factor in making an investment. Investing is a risk and, as with all risks, a positive return is not guaranteed. Past performance does not indicate future results.