Education Savings Account (ESA)

Coverdell Education Savings Account (also known as an Education Savings Account, a Coverdell ESA, a Coverdell Account, or just an ESA), is a tax-advantaged investment account designed to encourage savings to cover future education expenses (elementary, secondary or college), such as tuition, books, uniform, computers or transportation.

The total contributions for the beneficiary of this account cannot be more than $2,000 in any year, no matter how many accounts have been established. A beneficiary is someone who is under age 18 or is a special needs beneficiary.

Contributions to an ESA are not deductible, but amounts deposited in the account grow tax-free until distributed. The beneficiary will not owe tax on the distributions if they are less than a beneficiary’s qualified education expenses at an eligible institution. This benefit applies to qualified higher education expenses as well as to qualified elementary and secondary education expenses.

Key Points of an ESA:

• Distributions are tax-free as long as they are used for qualified education expenses, such as tuition and fees, required books, supplies, computers, equipment, qualified expenses for room and board, and some transportation expenses.
• There is no tax on distributions if they are for enrollment or attendance at an eligible educational institution. This includes any public, private or religious school that provides elementary or secondary education as determined under state law. Eligible institutions also include any college, university, vocational school or other post-secondary educational institution eligible to participate in a student aid program administered by the Department of Education. Virtually all accredited public, nonprofit, and privately owned post-secondary institutions are eligible.
• The Hope and lifetime learning credits can be claimed in the same year the beneficiary takes a tax-free distribution from a Coverdell ESA, as long as the same expenses are not used for both benefits.
• If the distribution exceeds qualified education expenses, a portion will be taxable to the beneficiary and will usually be subject to an additional 10% tax. Exceptions to the additional 10% tax include the death or disability of the beneficiary or if the beneficiary receives a qualified scholarship.

Contribution Limits and Mandatory Distribution

There are contribution limits for taxpayers based on the contributor’s Modified Adjusted Gross Income. Contributions to a Coverdell ESA may be made until the due date of the contributor’s return, without extensions.

If there is a balance in ESA when the beneficiary reaches age 30, it must generally be distributed within 30 days. The portion representing earnings on the account will be taxable and subject to the additional 10% tax. The beneficiary may avoid these taxes by rolling over the full balance to another ESA for another family member

You Can Self-Direct Your Child's ESA

Are you interested in creating a potentially tax-free education savings account while having the ability to self-direct those funds into alternative investments?

With a self directed ESA, you have the ability to save money and build your child's education tax-free. By self directing the funds in an educational IRA into both traditional and non-traditional investments giving more flexibility based on when your child will need the money.

Important differences between ESAs and 529 plans

• ESAs have lower maximum contribution limits; currently $2,000 can be contributed per year per child, while 529 plans generally have no restrictions on contributions, up to the maximum lifetime contribution.
• Coverdell ESAs can allow almost any investment inside including stocks, bonds, and mutual funds, while 529 plans only allow a choice among a number of state run allocation programs. The rules for investments allowed in ESAs are the same as those for IRAs.
• Balances in a ESA must be disbursed on qualified education expenses by the time the beneficiary is 30 years old or gifted to another family member below the age of 30 in order to avoid taxes and penalties; there is no age limit for 529 plans
• ESAs allow withdrawing the money tax free for qualified elementary and secondary school expenses; 529 plans do not.
• The income level of a donor may affect contributions into a ESA, but would not affect contributions to a Section

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