Definition
A Coverdell Education Savings Account (ESA) is a form of Individual Retirement Account (previously known as an Education IRA) that allows parents, relatives, or other eligible individuals to contribute up to $2,000 per year for each child up to the age of 18. This type of savings account is intended to cover future education expenses.
Key Characteristics:
- Contributions are made with after-tax dollars and do not provide a tax deduction.
- The assets in a Coverdell ESA can grow tax-free.
- Withdrawals used for qualifying education expenses are also tax-free.
- Contributions are phased out for married couples filing jointly with adjusted gross incomes (AGIs) between $190,000 and $220,000 and for singles with AGIs between $95,000 and $110,000.
- Couples with AGIs over $220,000 and singles with AGIs over $110,000 are ineligible to contribute.
Examples
Parental Contributions: Jane and John, married with a combined adjusted gross income of $180,000, contribute $2,000/year to their daughter Emily’s Coverdell ESA. This money grows tax-free and can be withdrawn tax-free to pay Emily’s college tuition, books, and room and board.
Investment Growth: Michael opens a Coverdell ESA for his son, investing in a mix of stocks and mutual funds. Over 10 years, the account grows to $30,000. Michael can use these funds, without tax penalties, to pay for his son’s college expenses.
Frequently Asked Questions
Q1: Can grandparents contribute to a Coverdell ESA? A1: Yes, any eligible individual, including grandparents, can contribute to a Coverdell ESA as long as the $2,000 annual limit per child is not exceeded.
Q2: What happens if the funds are not used for education expenses? A2: If withdrawals are not used for qualifying education expenses, the earnings portion of the withdrawal is subject to income tax and an additional 10% penalty.
Q3: Are there any restrictions on how the invested money can be used? A3: Yes, the money in a Coverdell ESA must be used for qualifying educational expenses to benefit from tax-free withdrawals. These include tuition, fees, books, supplies, and room and board at eligible educational institutions.
Q4: What types of investments are allowed in a Coverdell ESA? A4: Funds in a Coverdell ESA can be invested in a variety of assets, including stocks, bonds, mutual funds, and other investments typically available in IRAs.
Q5: Can I continue contributing to the Coverdell ESA after my child turns 18? A5: No, contributions can only be made until the beneficiary reaches the age of 18, unless the beneficiary is a special needs individual.
Related Terms
- Individual Retirement Account (IRA): A savings account with tax advantages that individuals can use to save and invest long-term.
- Adjusted Gross Income (AGI): An individual’s total gross income minus specific deductions, used to determine tax bracket and eligibility for various tax benefits.
- Qualified Education Expenses: Expenses required for the enrollment or attendance at an eligible educational institution, including tuition, fees, books, supplies, and room and board.
Online References
Suggested Books for Further Studies
- Savingforcollege.com’s Family Guide to College Savings by Joseph F. Hurley
- Finances for Kidz: Jamnagar, Primary Textbook - Kid-Friendly Finance including the Coverdell Education Savings Account by Neale S. Godfrey
- The College Savings Resource Guide by Brian Safdari
Fundamentals of Coverdell Education Savings Account: Finance Basics Quiz
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