Coverdell Education Savings Accounts (ESAs)

Coverdell education savings accounts (ESAs) are tax-advantaged accounts that allow taxpayers to save money for education. The earnings are tax-free if used for qualified education expenses. ESAs can be used to pay for education expenses at every level of education -- from kindergarten to graduate school -- if the education is provided by eligible education institutions.

Contributions to Coverdell ESAs aren’t deductible and aren’t reported on your tax return. However qualified distributions are tax-free.

You open a Coverdell ESA for the benefit of another person (the beneficiary), usually your child. However, the beneficiary doesn’t have to be your child or even a relative. Generally, the beneficiary must be under age 18 at the time of the contribution. However, the age limit is waived for certain special-needs beneficiaries. This includes individuals who, because of learning disabilities or certain physical, mental, or emotional conditions, require additional time to complete their education.

These are the rules for contributing to an education savings account:

Example: You're a single taxpayer with a modified AGI of $80,000. You have 3 grandchildren, and you want to set up ESAs for each of them. In addition, the other grandparents of 2 of your grandchildren have already contributed $750 to each of their ESAs. Because of the $2,000 limit, you can contribute only $1,250 for these grandchildren. For the third grandchild, though, you can contribute the full $2,000.

Modified AGI for this purpose is AGI plus any income excluded because of the foreign earned income exclusion, foreign housing exclusion or deduction, and excluded income of bona fide residents of American Samoa or Puerto Rico.

Eligible Educational Institutions

For ESA purposes, a postsecondary eligible educational institution is defined as:

An elementary and secondary educational institution is defined as:

Qualified Education Expenses

For ESA purposes, the definition of "qualified education expenses" depends on whether the expenses are for elementary and secondary or postsecondary education.

If the distribution is for a postsecondary school, the following expenses qualify for the deduction:

If the distribution is for an elementary or secondary school, the following expenses qualify for the deduction:

The amount of qualified expenses that you can use the ESA to pay for must be reduced by the amount of any nontaxable education benefits that the child receives, such as scholarships or Pell grants.

Example: Mary received a $1,000 tax-free scholarship and is also eligible for a $2,500 Pell grant. Her total expenses are $10,500. Because Mary receives nontaxable education benefits, she can only use $7,000 from her ESA to pay for qualified expenses:

$10,500 (Total expenses) - $3,500 (Scholarship and Pell grant) = $7,000

For more information, see Publication 970: Tax Benefits for Education.