In this post of the Best Ways to Save for College series, we will focus on Coverdell ESA plan.
What is Coverdell ESA?
Coverdell ESA is a tax advantaged savings plan for college, it also allows tax-free withdrawals for educational expenses from Kindergarten through college.
What are the Tax Benefits?
How to Use the Coverdell ESA Funds?
Funds in a Coverdell ESA may be used to pay qualifying higher education expenses in exchange for tax advantages. Qualifying expenses include tuition, fees, books, and equipment. Since 2002, qualifying expenses have been expanded to include room and board costs for students enrolled at least half-time at a qualifying institution, uniforms, and computer technology. Also since 2002, education costs for K-12 education (private, public, or parochial) are qualifying expenses for withdrawals from Coverdell ESAs.
Who Owns Coverdell ESA?
The Coverdell ESA is a custodial account that for all purposes except financial aid eligibility is owned by the beneficiary.
When the beneficiary of the account is a minor, an adult is a designated the “Responsible Individual” who must manage the Coverdell ESA on behalf of the child. The Responsible Individual makes all investment and spending decisions on behalf of the owner/beneficiary until the beneficiary turns 30, or at the age of majority.
Who Controls Coverdell ESA?
The Responsible Individual controls the funds in the account until the beneficiary reaches age 30, but may be able to transfer control to the student/owner when they reach the age of majority.
If the account is not closed before the beneficiary turns 30, the unused funds are automatically sent to the beneficiary, who will have to pay income taxes and penalties for non-use on any earnings.
What is the Contribution Limit?
Annual: $2,000 per year. Limits apply to the amount a beneficiary can receive from all donors combined in a tax year.
Can Coverdell ESA be Transferred?
Yes, Coverdell ESA can be transferred to another qualified family member who is not yet age 18.
What are the Investment Choices?
The Responsible Individual chooses the investment vehicle depending on those offered by the financial firm at which the Coverdell ESA is established.
What is the Impact on Financial Aid?
Parent funded Coverdells (Coverdells for which the parent of the dependent student is the “Responsible Individual”) are treated on the same manner as other parental assets.
What if Coverdell ESA is Not Used for College?
Earnings on funds not used for college (or K through 12 expenses) are subject to federal, state and local taxes and a 10% penalty. Since the child is the owner, the taxation and penalty are calculated at the child’s tax rates.
Account must be liquidated if not exhausted or transferred to another family member by the beneficiary’s 30th birthday, unless the beneficiary is disabled. This liquidation will trigger the above taxation and penalty.
What are the Other Important Things to Know about Coverdell ESA?
a. Limited Contribution for high income families
Coverdell contributions are limited to taxpayers with modified Adjusted Gross Incomes below certain thresholds. Single filers whose modified AGI is less than $95,000 may make the complete $2,000 annual contribution; eligibility is phased out and a partial contribution may be made by single filers with modified adjusted gross incomes between $95,000 and $110,000. No contribution can be made by a single filer whose modified AGI is greater than $110,000.
Donors who file joint tax returns may make the complete $2,000 contribution if their modified AGI is less than $190,000. Those with modified AGIs between $190,000 and $220,000 may make partial contributions.
b. Eligible Distribution to 529 Plan
Assets in a Coverdell ESA may be transferred into a 529 Savings Plan or a qualified Prepaid Tuition plan that has the Coverdell account owner (the student) as a beneficiary. This is considered an “eligible distribution”.
c. Read Agreements Carefully
Coverdell ESA adoption agreements (the enrollment contracts that financial services forms require Responsible Individuals to sign in order to open the account) may define plan specific limits that, among other things, may limit the right of the Responsible Individual to change account beneficiaries, transfer control of the account to the child-owner at the age of majority, etc. Before investing in a Coverdell, read these documents thoroughly.
What is Coverdell ESA?
Coverdell ESA is a tax advantaged savings plan for college, it also allows tax-free withdrawals for educational expenses from Kindergarten through college.
What are the Tax Benefits?
- Contributions: Not deductible.
- Growth: Tax-deferred.
- Withdrawals: Tax-free for federal taxes when used for qualified expenses; may be subject to state and local taxes.
How to Use the Coverdell ESA Funds?
Funds in a Coverdell ESA may be used to pay qualifying higher education expenses in exchange for tax advantages. Qualifying expenses include tuition, fees, books, and equipment. Since 2002, qualifying expenses have been expanded to include room and board costs for students enrolled at least half-time at a qualifying institution, uniforms, and computer technology. Also since 2002, education costs for K-12 education (private, public, or parochial) are qualifying expenses for withdrawals from Coverdell ESAs.
Who Owns Coverdell ESA?
The Coverdell ESA is a custodial account that for all purposes except financial aid eligibility is owned by the beneficiary.
When the beneficiary of the account is a minor, an adult is a designated the “Responsible Individual” who must manage the Coverdell ESA on behalf of the child. The Responsible Individual makes all investment and spending decisions on behalf of the owner/beneficiary until the beneficiary turns 30, or at the age of majority.
Who Controls Coverdell ESA?
The Responsible Individual controls the funds in the account until the beneficiary reaches age 30, but may be able to transfer control to the student/owner when they reach the age of majority.
If the account is not closed before the beneficiary turns 30, the unused funds are automatically sent to the beneficiary, who will have to pay income taxes and penalties for non-use on any earnings.
What is the Contribution Limit?
Annual: $2,000 per year. Limits apply to the amount a beneficiary can receive from all donors combined in a tax year.
Can Coverdell ESA be Transferred?
Yes, Coverdell ESA can be transferred to another qualified family member who is not yet age 18.
What are the Investment Choices?
The Responsible Individual chooses the investment vehicle depending on those offered by the financial firm at which the Coverdell ESA is established.
What is the Impact on Financial Aid?
Parent funded Coverdells (Coverdells for which the parent of the dependent student is the “Responsible Individual”) are treated on the same manner as other parental assets.
What if Coverdell ESA is Not Used for College?
Earnings on funds not used for college (or K through 12 expenses) are subject to federal, state and local taxes and a 10% penalty. Since the child is the owner, the taxation and penalty are calculated at the child’s tax rates.
Account must be liquidated if not exhausted or transferred to another family member by the beneficiary’s 30th birthday, unless the beneficiary is disabled. This liquidation will trigger the above taxation and penalty.
What are the Other Important Things to Know about Coverdell ESA?
a. Limited Contribution for high income families
Coverdell contributions are limited to taxpayers with modified Adjusted Gross Incomes below certain thresholds. Single filers whose modified AGI is less than $95,000 may make the complete $2,000 annual contribution; eligibility is phased out and a partial contribution may be made by single filers with modified adjusted gross incomes between $95,000 and $110,000. No contribution can be made by a single filer whose modified AGI is greater than $110,000.
Donors who file joint tax returns may make the complete $2,000 contribution if their modified AGI is less than $190,000. Those with modified AGIs between $190,000 and $220,000 may make partial contributions.
b. Eligible Distribution to 529 Plan
Assets in a Coverdell ESA may be transferred into a 529 Savings Plan or a qualified Prepaid Tuition plan that has the Coverdell account owner (the student) as a beneficiary. This is considered an “eligible distribution”.
c. Read Agreements Carefully
Coverdell ESA adoption agreements (the enrollment contracts that financial services forms require Responsible Individuals to sign in order to open the account) may define plan specific limits that, among other things, may limit the right of the Responsible Individual to change account beneficiaries, transfer control of the account to the child-owner at the age of majority, etc. Before investing in a Coverdell, read these documents thoroughly.
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