Coverdell ESA for College Savings: What You Need to Know

If your to-do list includes “figure out how to save for your child’s education,” you’re probably feeling overwhelmed. It’s a challenge to save up for a college education. To help, the government created the Coverdell Education Savings Account (ESA).

Let’s take a look at the Coverdell ESA and how it can help you manage your college savings journey.

What Is a Coverdell ESA?

Formerly known as the Education IRA, the Coverdell ESA is a tax-advantaged investment vehicle used for college and other qualifying educational expenses. Like an IRA, it helps boost your overall college savings because you aren’t taxed on your overall investment earnings. You also aren’t taxed when you withdraw funds, as long as they are used for qualifying higher education expenses like tuition, fees, books and supplies.

What You Need to Know

A Coverdell ESA isn’t for everyone. For starters, the maximum total annual contribution is $2,000 per designated beneficiary (and that’s across all Coverdell ESAs for a single designated beneficiary, so there’s no getting around this one).

Distributions are only tax-free if they are equal to or less than the beneficiary’s annual adjusted qualified education expenses. Any money you take out above the amount you can spend on qualified education expenses may be subject to both income tax and a 10 percent penalty.

Additionally, the amount you make affects how much you can contribute. Depending on your household’s modified adjusted gross income (MAGI), the $2,000 per designated beneficiary contribution limit may be lower. If your income is above a certain threshold — currently $110,000 for single filers or $220,000 for joint filers — you can’t use a Coverdell ESA at all.

Finally, keep in mind that depending on who owns the account, having one may limit the amount of financial aid available to your child, so it’s important to weigh all the factors before selecting a college savings plan.

The Coverdell ESA can be an excellent vehicle to help save for your child’s college education. But if it doesn’t meet your criteria — if you earn more than the income limits, for example, or you wish to set aside more than $2,000 per year — then you may want to consider a 529 college savings plan instead.

Make sure you compare education savings accounts before committing to a plan. Saving for college can be a challenge, but choosing a tax-advantaged savings account can make it much more manageable.

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