What Is a Coverdell Education Savings Account (ESA)?
A Coverdell Education Savings Account (ESA) is a trust account created by the U.S. government to assist families in funding educational expenses for beneficiaries who must be under the age of 18 when the account is established. The age restriction may be waived for special needs beneficiaries. While more than one ESA can be set up for a single beneficiary, the total maximum contribution per year for any single beneficiary is $2,000.
Key Takeaways
- Coverdell funds can be used to pay for a wide variety of expenses for young people attending eligible schools.
- Coverdell funds must be used by the time a student is age 30 or taxes, fees, and penalties will accompany withdrawals.
- Total family member contributions to aCoverdell Education Saving Accountare limited to $2,000 a year.
- Coverdell accounts are similar to 529 plans; however, for elementary and secondary school, Coverdell funds are allowed for other school expenses.
How a Coverdell Education Savings Account (ESA) Works
Formerly called an education IRA, the ESA allows families to increase investment earnings as long as the funds are used for educational purposes. When the contributions are distributed, they are tax-free assuming they are less than the account holder's annual adjusted qualified education expenses, including tuition, books, equipment, special needs services, and even academic tutoring. ESA account funds can be used for primary and secondary schools (grades K–12) as well as higher education.
If distributions are higher than the expenses, the gains are taxed at the account holder's rate, rather than the contributor's rate, which is typically higher. The Coverdell ESA is restricted to families below a certain income level based on their adjusted gross income (AGI). The AGI requirements are $95,000 or below for single taxpayers and $190,000 or below for married taxpayers for the full $2,000 contribution limit. The contribution limit is lower for higher earners and is phased out for single taxpayers with an AGI of $110,000 or more and for joint filers with an AGI of $220,000 or more.
Coverdell Education Savings Accountsvs. 529 Plans
ESAs may be established at brokerages and other financial institutions. These accounts are comparable to the 529 tax-free college savings plan. It is permissible to have a 529 plan as well as an ESA for the same beneficiary’s education expenses. However, there is no annual limit on the amount that may be deposited into a 529 plan.
Upon the beneficiary reaching age 30, any remaining funds in the ESA must be disbursed, unlike a 529 plan. The exception to this rule is if the beneficiary of the ESA qualifies as a special needs beneficiary.
529 plans can be used to pay off up to $10,000 in student loans and to pay for qualified expenses related to apprenticeship programs approved by the U.S. Department of Labor. There are no restrictions on the income level of the contributors to a 529 plan; however, fees may apply to 529 accounts and the investment has no guaranteed returns.
Corporations and trusts may make contributions to an ESA without the restriction on adjusted gross income.
What Is the Difference Between a 529 and a Coverdell?
The difference between a 529 and a Coverdell for elementary and secondary schools is that a 529 can only be used for tuition, while a Coverdell can pay for tuition and other school expenses.
How Much Can You Contribute to a Coverdell Account?
The annual contribution limit for a Coverdell account is $2,000 per beneficiary. This is for single taxpayers with an AGI of $95,000 and below as well as joint taxpayers with an AGI of $190,000 or below. Above these AGI levels, the contribution amount is reduced and completely phased out for single taxpayers with an AGI of $110,000 or more and joint taxpayers with an AGI of $220,000 or more.
What Happens to a Coverdell if the Child Doesn't Go to College?
If the child doesn't go to college and doesn't use the money by the time they are 30, the child (beneficiary) will have the amount distributed to them and will be taxed on the amount.
The Bottom Line
The Coverdell Education Savings Account was created to help pay for educational expenses for qualified families. The account must be established before the beneficiary turns 18. The maximum annual contribution is $2,000 and must be used by the time the beneficiary is 30 years old.
Correction—April 28, 2023: A previous version of this article incorrectly described the Coverdell Education Savings Account as a tax-deferred account instead of a tax-free account until the beneficiary reaches age 30.
FAQs
In general, the designated beneficiary of a Coverdell ESA can receive tax-free distributions to pay qualified education expenses. The distributions are tax-free to the extent the amount of the distributions doesn't exceed the beneficiary's qualified education expenses.
How does Coverdell ESA work? ›
In 2002, the Education IRA was renamed the Coverdell Education Savings Account. These accounts work very much like a 529 plan, offering tax-free investment growth and tax-free withdrawals when the funds are spent on qualified education expenses.
What are the disadvantages of a Coverdell education savings account? ›
Coverdell ESA Disadvantages
Its annual contribution maximum pales in comparison to 529 plan limits. The contribution limit for Coverdell ESAs stick at $2,000 per student. This means that if a parent and grandparent each opened a Coverdell ESA for one child, the total of both accounts can't exceed $2,000.
What are the rules for Coverdell ESA? ›
How to open and contribute to an ESA
- No more than $2,000 per year can be put in a child's ESA(s). ...
- The $2,000 maximum is dependent on your filing status and modified adjusted gross income (MAGI). ...
- The money must be used (or transferred to another beneficiary) before the child turns 30.
What are qualified education expenses for a Coverdell? You can generally use tax-free education savings account withdrawals for more than just the cost of school (tuition and fees). It's also possible to pay for books, equipment, supplies or even to buy a computer with tax-free Coverdell ESA distributions.
When can I withdraw from Coverdell? ›
If a distribution exceeds the beneficiary's qualified education expenses, a portion of the earnings is taxable to the beneficiary. Amounts remaining in the account must be distributed within 30 days after the designated beneficiary reaches age 30, unless the beneficiary is a special needs beneficiary.
Is a Coverdell ESA worth it? ›
The biggest benefits of a Coverdell ESA are its extremely low fees, tax-free withdrawals on qualified expenses, and the ability to choose any investment your brokerage offers (e.g., stocks, bonds, exchange-traded funds (ETFs), options). The breadth of qualified expenses is also wider than those for 529 plans.
Why use a Coverdell instead of 529? ›
Coverdell ESAs allow savings for K-12 while 529 plans are just for college. Coverdell ESAs have income limits while 529 plans do not. You have more investment options with Coverdell ESAs compared to 529s. Coverdell funds must be used or transferred by age 30, while there is no age requirement with a 529.
What happens to Coverdell if child doesn't go to college? ›
What happens to Coverdell if the child doesn't go to college? If your child doesn't go to college, they can withdraw the money from the account (in fact, any remaining funds will be automatically distributed to them if not used when they turn 30) and they will be taxed on the withdrawal.
Can Coverdell be used for rent? ›
Coverdell ESAs can be used only to pay for qualified education expenses, such as tuition and fees; the cost of books, supplies and other equipment; and in some situations, the cost of room and board.
Q. What happens to the ESA if a child doesn't use the money? turns 30,* the unused portion can be rolled over to another eligible family member under age 30.
What is the income limit for Coverdell? ›
In 2024, a family with an adjusted gross income below $190,000 or a single taxpayer with an adjusted gross income below $95,000 is eligible to open and contribute to a Coverdell account up to the annual contribution limit.
What expenses can be paid with Coverdell funds? ›
Once your child is in school, you can take Coverdell education savings account withdrawals to cover qualifying education expenses tax-free. Qualified expenses include tuition, books, equipment, academic tutoring and even special needs services. In addition to college expenses, you can also cover eligible K-12 expenses.
Who pays taxes on Coverdell? ›
The distributions from a Coverdell are tax-exempt as long as they are used to cover qualifying education expenses. Qualified expenses are the cost of attending a school or for a special needs beneficiary and include; tuition and fees, books, supplies, and required materials for a course of study.
Does Coverdell affect fafsa? ›
Yes. Qualified educational benefits and education savings accounts (like 529 Plans) are reported on the FAFSA. For the FAFSA, investments include qualified educational benefits or education savings accounts (e.g., Coverdell savings accounts, 529 college savings plans and the refund value of 529 prepaid tuition plans).
Can Coverdell be converted to Roth IRA? ›
Coverdell Education Savings Accounts can be rolled over to 529 plans. Can they, too, be rolled over to a Roth IRA? No. SECURE 2.0 does not allow for Coverdell ESA-to-Roth IRA rollovers.
Is a Coverdell ESA better than a 529 plan? ›
Coverdell ESAs allow savings for K-12 while 529 plans are just for college. Coverdell ESAs have income limits while 529 plans do not. You have more investment options with Coverdell ESAs compared to 529s. Coverdell funds must be used or transferred by age 30, while there is no age requirement with a 529.
Can Coverdell ESA be used for rent? ›
Coverdell ESAs can be used only to pay for qualified education expenses, such as tuition and fees; the cost of books, supplies and other equipment; and in some situations, the cost of room and board.
Who pays taxes on Coverdell ESA? ›
The distributions from a Coverdell are tax-exempt as long as they are used to cover qualifying education expenses. Qualified expenses are the cost of attending a school or for a special needs beneficiary and include; tuition and fees, books, supplies, and required materials for a course of study.
What happens with Coverdell when a child turns 18? ›
Generally, the beneficiary of a Coverdell ESA can be anyone under age 18. Once that person reaches 18, you can no longer make contributions on his or her behalf. The exception is if the beneficiary is a special needs child, in which case you can still contribute to the account after the beneficiary reaches age 18.
