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:
You can contribute to as many Coverdell ESAs as you want.
Contributions are limited to $2,000 per child, regardless of the number of accounts or how many people contribute.
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.
The $2,000 contribution limit is an overall limit on contributions per child. However, the amount that you can contribute is reduced if your modified AGI exceeds $95,000 on a single return ($190,000 if filing a joint return). The contribution is completely phased out for single taxpayers if their MAGI is $110,000 or more ($220,000 on a married filing jointly return). You must make your contribution by the time your tax return is due (usually April 15).
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.
You can contribute to both an education savings account and a qualified state tuition plan for the same child in the same year.
When a beneficiary reaches age 30 or dies, any assets remaining in the ESA must be withdrawn or rolled over to another qualified beneficiary within 30 days. This doesn't apply to special-needs beneficiaries, however. You can claim an education tax credit (if you qualify) in the same year that you make a withdrawal from an ESA
The beneficiary of an ESA may be changed without tax consequences if: (1) the new beneficiary is a member of the same family or former beneficiary and (2) the new beneficiary is under age 30 or a special-needs beneficiary at the time of the change. This change may be made by having the trustee change the name on the account if permitted under the plan rules or by rolling the ESA over into another ESA of an eligible beneficiary. You might want to do this if a child graduates or reaches age 30, and there's still money left in the account.
For ESA purposes, a postsecondary eligible educational institution is defined as:
Any accredited public or private college, university, vocational school, or other postsecondary educational institution eligible to participate in U.S. Department of Education Federal Student Aid programs.
In addition, certain foreign institutions participate in the U.S. Department of Education's Federal Student Aid programs. A list of these foreign schools can be found on the department's Web site at www.fafsa.ed.gov.
An elementary and secondary educational institution is defined as:
Any public, private, or religious school, as determined under state law, that provides elementary or secondary education (kindergarten through grade 12).
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:
Tuition, fees, books, supplies, and equipment required for enrollment or attendance
Special-needs services for a special-needs child that are incurred in connection with enrollment or attendance
Room and board incurred by a student enrolled for at least one-half the full-time academic workload to the extent that the costs do not exceed the greater of:
The allowance for room and board, as determined by the eligible educational institution for a particular academic period, or
The amount charged if the student is residing in housing owned or operated by the eligible educational institution.
Computer technology, including hardware, software and internet access, used by the account beneficiary and family during the years the student is enrolled at an eligible institution.
If the distribution is for an elementary or secondary school, the following expenses qualify for the deduction:
Tuition, fees, books, supplies, equipment, and academic tutoring incurred in connection with enrollment or attendance at a public, private, or religious school
Special-needs services for a special-needs child
Room, board, uniforms, transportation, and supplementary items and services (including extended day programs), if they’re required or provided in connection with attendance or enrollment at the school
The purchase of computer technology, equipment, or Internet access and related services, if it’s to be used by the child and the child’s family during any of the years the child is in elementary or secondary school. However, this doesn’t include computer software designed for sports, games, or hobbies, unless it’s predominantly educational in nature.
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.