WHAT IS A COVERDELL EDUCATION SAVINGS ACCOUNT?
If youre starting to plan for your childs education, and wondering about ways you could start saving for college, then a Coverdell Education Savings Account might be a very good option for you to look into. Basically, a Coverdell Education Savings Account (ESA) is a tax advantaged investment account created as an incentive to help parents and students save for education expenses. Coverdell ESAs allow almost any investment inside including stocks, bonds, and mutual funds, unlike similar “529 plans” which only allow a choice among a number of state run allocation programs. Distributions from a Coverdell Education Savings Account are tax-free as long as they are used for qualified education expenses, such as tuition and fees, required books, supplies and equipment and qualified expenses for room and board.
GET A HEAD START ON SAVING FOR YOUR CHILDS EDUCATION
If you want to open a Coverdell Education Savings Account, its a good idea to start as early in the beneficiarys life as possible to reap the maximum benefit. Typically, a beneficiary of a Coverdell Education Savings Account must be under age 18, or else is a special needs beneficiary. The reason for opening an account as early in the beneficiarys life as possible is due to the fact that the total contributions for the beneficiary of a Coverdell Education Savings Account cannot be more than $2,000 in any one year, no matter how many accounts have been established, so if you are in a position to start investing in your childs education now, you might as well get started as early as possible.
NOT TAX DEDUCTABLE BUT NO TAXES ON DISTRUBUTIONS
Another important issue to consider is that contributions to a Coverdell Education Savings Account are not deductible, however money deposited in the account will grow tax free until it is distributed. There is no tax on distributions if they are for enrollment or attendance at an eligible educational institution. This benefit applies to qualified higher education expenses, as well as to qualified elementary and secondary education expenses. This includes any public, private or religious school that provides elementary or secondary education as determined under state law. Eligible institutions that can be paid from a Coverdell Education Savings Account also include any college, university, vocational school or other postsecondary educational institution eligible to participate in a student aid program administered by the Department of Education. Virtually all accredited public, nonprofit, and proprietary (privately owned profit-making) postsecondary institutions are eligible.
WHAT ARE THE LIMITS OF A COVERDELL EDUCATION SAVINGS ACCOUNT?
While a Coverdell Education Savings Account offers great potential to save for your childs education expenses, there are some limits to what is possible that should be noted. For one, there are contribution limits for taxpayers based on the contributors Modified Adjusted Gross Income. Additionally, contributions to a Coverdell Education Savings Account for a particular tax year may only be made until the due date of the contributors return, without extensions.
If the distribution of a Coverdell Education Savings Account 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.
Finally, if there is a balance in the Coverdell ESA when the beneficiary reaches age 30, it must generally be distributed within 30 days. The portion of a Coverdell Education Savings Account 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 Coverdell Education Savings Account for another family member. For more details, see IRS Publication 970, Tax Benefits for Higher Education (at IRS.gov) or call 800-TAX-FORM (800-829-3676).
