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Money Management (Distributed by the New Jersey Society of Certified Public Accountants)

Understanding Coverdell Education Savings Accounts


Coverdell Education Savings Accounts (ESAs) are one of the most popular methods of saving for college. To help you fully understand how these accounts can be used to save for future tuition, the New Jersey Society of Certified Public Accountants (NJSCPA) provides answers to some of the most frequently asked questions about these unique savings vehicles:

What Is a Coverdell Education Savings Account?
Previously called an Education IRA, a Coverdell Education Savings Account (ESA) is a trust or custodial account set up to pay for qualified educational expenses of a designated beneficiary.

Are There Age Restrictions for Beneficiaries of Coverdell Accounts?
A Coverdell account can be established for the benefit of a beneficiary under age 18. Once the beneficiary reaches age 18, you may no longer contribute to the account. This age limit does not apply to an individual with special needs.
If there are unused funds remaining in the account when the beneficiary reaches age 30, they must be withdrawn within 30 days. Again, the age limit doesn't apply to those with special needs. If the distributed funds exceed qualified education expenses, then part of the earnings included in the distribution is taxable in addition to a 10 percent penalty.
If you are unable to distribute the funds to the account beneficiary, you have another alternative. Unused funds can be rolled over into a Coverdell for another eligible family member of the beneficiary or it may be maintained by changing the designated beneficiary. This individual would also have until age 30 to use the funds for qualified education expenses.

How Much Can You Contribute to a Coverdell Account?
You may contribute up to $2,000 annually per beneficiary to a Coverdell ESA. The maximum $2,000 contribution limit is phased out for single filers with modified adjusted gross income (MAGI) between $95,000 and $110,000, and for joint filers with MAGI between $190,000 and $220,000. No contribution is allowed once your MAGI reaches $110,000 for single filers and $220,000 for joint filers.
You have until the due date of your return (not including extensions) to make a contribution and have it apply to the previous year.

What Are the Tax Benefits of a Coverdell?
Contributions are not tax-deductible, but the earnings grow tax free and so do withdrawals as long as the distributions are used for qualified education expenses.

What Expenses Qualify for Tax-Free Withdrawals?
For students attending eligible colleges, universities and vocational schools, qualified expenses for a beneficiary who is at least a half-time student include tuition, fees, books, supplies and reasonable room and board. The funds in a Coverdell ESA can also be used to cover the costs of attending kindergarten through grade 12. In addition to tuition, these costs can include uniforms, tutoring, computers, software and transportation.

Who Can Contribute to a Coverdell?
Any adult - parents, grandparents, aunts and uncles, or friends - may contribute to a child's Coverdell account as long as his or her income falls within the guidelines. However, the total contribution from all sources cannot exceed $2,000 annually per beneficiary.

Can I Also Open a Section 529 Plan?
You can contribute to both a Coverdell account and a Section 529 plan in the same year. Be aware that there may be gift tax implications if you give more than $11,000 per beneficiary.

How Do I Open a Coverdell Account?
Any bank, brokerage firm or mutual fund company that handles traditional IRAs can help you set up and manage a Coverdell account. The money can be invested in stocks, bonds, mutual funds or certificates of deposit. Consult with a CPA if you have additional questions about Coverdell savings accounts. If you don't have a CPA, you can easily locate one online using the NJSCPA Find-A-CPA service. Visit www.findacpa.org to locate a highly qualified professional who is right for you.

If you would like to receive more information on various financial matters, subscribe to E-CPA, the NJSCPA's free, monthly email newsletter. To subscribe, visit www.njscpa.org/finances or email a subscription request to e-cpa@njscpa.org.

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Money Management is a weekly column on personal finance distributed by the NJSCPA.

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