Coverdell Education Savings Account (ESA) Overview

October 2, 2009

Coverdell Education Savings Account History
Years ago, there used to be an account called the Education IRA. It was created by the government to help parents prepare for the costs of schooling for their children. This account was not that popular, because at the time, it had a $500 annual contribution limit. I remember clients telling me back then that the low limit “just wasn’t worth it.”

In 2002, like any smart company would do when their product isn’t getting used, Congress went back to the drawing board. It was re-branded as the Coverdell Education Savings Account or ESA (named after the main sponsor, Paul Coverdell, R-GA). The new & improved product took care of the biggest flaw by raising the annual contribution limit to $2,000.

Coverdell Account Contributions & Limits

That ESA limit is the same today, but it is subject to income thresholds. The person funding the account (whether it is a parent, grandparent, uncle, etc.) must have an AGI below $95,000 if single and $190,000 for anybody filing a joint return. These limits are phased out for income between $95,000 – $110,000 and $190,000 – $220,000 respectively. One way you can avoid this issue is by gifting the money to the child so that they make the contribution it to the ESA.

Contributions can be made until the beneficiary reaches the age of 18. The account must be depleted by the time that person reaches the age of 30 to avoid tax penalties. The custodian for the account can also appoint another eligible beneficiary.

Coverdell Investing Options

Unlike a 529 plan where you are limited to the investments of the specific sponsored plan, ESAs have the ability to invest in stocks, bonds, mutual funds, etc. Like the 529 plan or any other custodial account, the custodian has the authority to run the account and make investment decisions. However, those decisions must be based on the minor’s situation. For example, a 17 year old high school senior should not have their account invested in aggressive stocks if the money is to be used the next year for college.

Coverdell Distributions

All withdrawals for “qualified expenses” are tax free. “Qualified” is a broad term in this case for the IRS. All room, board & tuition, books, etc. qualify for the tax-free treatment. However, if your child wants an apartment off campus, the rent for that apartment is NOT qualified. The biggest difference between the ESA and a 529 is that the ESA allows you to use the funds for primary and secondary school expenses. 529s only allow the use of the funds post-high school graduation.

College Planning

Keep in mind the money inside an ESA is not factored into financial aid analysis because technically the funds are not owned by the beneficiary. Hopefully this info on the ESA gave you some things to consider when you look into investing in your child’s future. Some people may choose an ESA over a 529, others may choose both. Either way, use something, it will certainly be in your and your child’s best interest to do so.


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4 Responses to Coverdell Education Savings Account (ESA) Overview

  • Mrs. Tola Mbachu

    Can non-American citizens save for their children’s university education in america via this scheme?

  • Ben

    @William, thanks. I know they don’t have ESA’s in the UK but maybe they have something similar

  • William

    Really great info about coverdell Account and college fees plannings. Thanks for it.

    Willian Backham {UK}


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