You can save for a child’s educational expenses in several ways, including traditional savings accounts and more advanced, tax-advantaged accounts like a Coverdell education savings account. This type of account is similar to other educational savings accounts, such as 529s, but it offers more flexibility of use and investment control.

If you’re considering a Coverdell education savings account, you must understand key features and characteristics, such as income and contribution limits, age restrictions, and what expenses qualify.

What Is a Coverdell ESA?

A Coverdell education savings account (ESA) is a tax-advantaged investment account designed to help a child cover educational expenses. The account is opened in the name of a minor, and the beneficiary can use account funds to cover qualifying educational expenses, such as:

• Elementary or high school expenses include tuition, books, and uniforms.
• Higher education tuition.
• Room and board.
• Books, computers, and other academic resources or equipment.
• Tutoring or academic special needs services.

In addition to covering multiple educational expenses throughout a child’s life, this type of account also gives the custodian more control over how funds are invested. Investment options range from stocks and bonds to mutual funds, exchange-traded funds (ETFs), and even real estate investments.

Benefits of a Coverdell ESA

If you’re looking for an investment vehicle that will allow you to save for a child’s education, there are several reasons to consider a Coverdell ESA.

• Funds can cover a wide range of qualifying educational expenses for primary and secondary school as well as higher education.
• Coverdell ESAs offer far more investment opportunities when compared to a 529 savings account.

How Do Coverdell ESAs Work?

In general, anyone wanting to support a child’s academic growth financially can open a Coverdell ESA. This includes parents, grandparents, aunts and uncles, and non-relatives. However, there are additional IRS-set rules that govern eligibility and contributions.

Eligibility

To be eligible, the account beneficiary must be under 18. Individuals with special needs due to a mental, physical, or emotional condition are not subject to the 18-year-old cut-off. Income limits (discussed below) also impact eligibility.

Income Limits

If you’re filing a joint return, your combined income must be below $220,000 per year to be eligible to contribute to a Coverdell ESA. Single filers become ineligible once their income reaches $110,000 per year or more.

Contribution Limits

The base Coverdell ESA contribution limit is $2,000 per year, though the plan also has income-driven limits that can reduce (or eliminate) your annual contribution limit.

If you file taxes jointly and your modified adjusted gross income (MAGI) is between $190,000 and $220,000, your contribution limit will be reduced. Single filers can expect a reduced contribution limit if their income falls between $95,000 and $110,000. If your income exceeds those limits, you cannot contribute to the Coverdell ESA in that tax year.

Note that the Coverdell ESA contribution is applied across all accounts, not to a single account. If you have two or more Coverdell ESAs, the combined contribution limit is $2,000 or the reduced contribution level if your income exceeds the above mentioned limits.

Withdrawals

You can take a tax-free withdrawal from a Coverdell ESA at any time to cover qualifying educational expenses, whether in elementary school or while a child is enrolled in a higher educational program, such as at a college or university. If the amount withdrawn exceeds the educational expense, the excess becomes taxable.

Unless the account’s beneficiary is considered special needs, all funds must be withdrawn from the account within 30 days of the beneficiary’s 30th birthday.

What’s the Difference Between a Coverdell ESA and a 529

Coverdell ESAs and 529 accounts can help pay for a child’s educational expenses, but several differences may make one type of account better suited for your needs.

Coverdell ESAs are one of the best ways to invest in your child’s future. Contact Horizon Trust if you are interested in opening a Coverdell ESA or any other tax-advantaged account for your child, such as a Custodial Roth IRA.

FAQs

Who can contribute to a Coverdell ESA?

Anyone can contribute to a Coverdell ESA, including parents, grandparents, aunts and uncles, and non-relatives, such as family and friends. However, income restriction may reduce the allowed contribution or eliminate it altogether.

Can Coverdell ESA funds be used for non-education expenses?

No, Coverdell ESA funds should not be used for non-education expenses. Qualifying expenses are limited to K-12 expenses, such as tuition and books, as well as higher educational expenses, such as tuition, books, room and board, educational equipment, etc.

What happens if funds are not used for educational purposes?

If funds in a Coverdell ESA are used for non-educational expenses, they will be considered income and taxed at the beneficiary’s current tax rate. An additional 10% penalty may also be applied.

Can multiple Coverdell ESAs be opened for one beneficiary?

Yes, multiple Coverdell ESAs can be opened for one beneficiary. However, the total contribution among all Coverdell ESAs must not exceed $2,000.