A Coverdell Education Savings Account (ESA) is an account created as an incentive to help parents and students save for education expenses.
The total contributions for the beneficiary of a Coverdell Education Savings Account cannot be more than $2,000 in any year, no matter how many accounts have been established. A beneficiary of a Coverdell Education Savings Account is someone who is under age 18 or is a special needs beneficiary.
Contributions to a Coverdell Education Savings Account are not deductible, but amounts deposited in the account grow tax free until distributed. The beneficiary will not owe tax on the distributions if they are less than a beneficiary’s qualified education expenses at an eligible institution. This benefit applies to qualified higher education expenses as well as to qualified elementary and secondary education expenses. Annual contributions may be made to a Coverdell Education Savings Account until the beneficiary reaches age 18, or is a special needs beneficiary.
Here are some things to remember about Distributions from a Coverdell Education Savings Account:
- Distributions to 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.
- There is no tax on distributions if they are for enrollment or attendance at an eligible educational institution. 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.
- The Hope and lifetime learning credits can be claimed in the same year the beneficiary takes a tax-free distribution from a Coverdell Education Savings Account, as long as the same expenses are not used for both benefits.
- 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.
WHAT ARE THE LIMITS OF A COVERDELL EDUCATION SAVINGS ACCOUNT?
There are contribution limits for taxpayers based on the contributor’s Modified Adjusted Gross Income. Contributions to a Coverdell Education Savings Account may be made until the due date of the contributor’s return, without extensions.
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).
- Publication 970, Tax Benefits for Higher Education (PDF 368K)
- Tax Topic 310 — Coverdell Education Savings Accounts
- IRS Tax Tip 2007-48 — Offset Education Costs