How to Save for College: Coverdell Educational Savings Accounts

May 1, 2014 10:34:49 AM / by Jason Shaw

coverdell esa

As a parent in Iowa, you have many options for saving for your child’s educational expenses.  A Coverdell Educational Savings Account (ESA) is an attractive option for many parents.

It’s Not Just for College.

An advantage that the Coverdell ESA has over the popular Iowa 529 college savings plan is that it can be used not only for higher education expenses but also for elementary and secondary education.  This is a great benefit if you have a young child whom you would like to send to a private elementary and/or secondary school.

You Control the Investments

Another reason some parents prefer the Coverdell ESA to the Iowa 529 plan is that while a 529 plan offers a limited menu of investment options, a Coverdell account allows parents complete freedom of choice in their investments.  Choosing investments is complex and involves risk, however, so it is wise to get the advice of a qualified financial advisor when making your selections.

Your Contributions Grow Tax-Deferred.

Although contributions to a Coverdell ESA are not tax deductible, the income earned is not taxable as long as it remains in the account.  As long as the funds are ultimately used for the beneficiary’s qualified educational expenses, those earnings will remain tax-free upon distribution.

Be Mindful of Limits.

There are limits on contributions to Coverdell accounts.  Total Coverdell contributions for any beneficiary cannot exceed $2,000, regardless of how many accounts are opened for the beneficiary.  For many families, this level of contribution will not be sufficient to meet a child’s college savings needs, so opening other types of accounts in addition to the Coverdell is advisable.

Furthermore, no individual may contribute to a Coverdell ESA whose Modified Adjusted Gross Income (MAGI) is $110,000 or more ($220,000 for married joint filers).  Organizations, however, such as corporations and trusts, may contribute to these accounts without being subject to income limits.  Talk to a professional financial advisor to determine whether making contributions through an organization is an appropriate option for you.

Coverdell ESAs also have age limits for beneficiaries.  Contributions can be made only for beneficiaries who are under the age of 18 or who have special needs.  If there is a balance in the account when the beneficiary reaches age 30, it generally must be distributed to the beneficiary within 30 days.  If the distribution is not used for qualified educational expenses, then the earnings on contributions are subject to tax and an additional 10% penalty.  This can be avoided by rolling the balance into another Coverdell account for a family member before the current beneficiary is 30 years old.

You may make contributions to the ESA after the end of the calendar year and still count them for the previous tax year, as long as they are made prior to the filing deadline.

For complete details on Coverdell ESA contributions, rollovers, distributions, and income limits, see the IRS website.

The professionals at Boelman Shaw Tax & Financial Planning can provide you with information and advice about your choices in Iowa college savings plans.  Contact us to discuss planning for your child’s educational future.

Tax and accounting services provided through Boelman Shaw & Company, LLC. Advisory services provided through BSC Capital Partners, LLC a state of Iowa registered investment advisor.

Topics: Financial Planning

Written by Jason Shaw