Frequently Asked Questions About Coverdell Education Savings Accounts

What is a Coverdell Education Savings Account?

Formerly known as an Education IRA, a Coverdell Education Savings Account (ESA), is a federally sponsored, tax-advantaged trust or custodial account set up to pay for qualified education expenses. Coverdell ESAs can be opened for any student who is under the age of 18 years. The assets, however, must be withdrawn by the time the student reaches the age of 30. Withdrawals for children with special needs generally are not subject to the age restrictions. Coverdell ESAs are named in honor of the late Senator Paul Coverdell who championed the original legislation that created the Education IRA.

What is the level of Coverdell ESA assets held in mutual funds?

Coverdell ESA assets invested in mutual funds totaled $5 billion at year-end 2006.

What is the tax treatment of Coverdell ESA contributions and earnings?

Coverdell ESA contributions are not tax deductible, but, like a Roth IRA, amounts deposited in the accounts grow tax-free until withdrawn. Withdrawals from Coverdell ESAs generally are tax-free to the extent that the amount of the withdrawal is not more than the beneficiary’s qualified education expenses.

Is there a limit to Coverdell ESA contributions?

Yes. Since 2002 the annual contribution limit has been a maximum of $2,000 per beneficiary. Prior to 2002, the maximum was $500 per beneficiary.

Who can contribute to a Coverdell ESA?

Parents, grandparents, other relatives, friends, and the child for whom the account is being established can contribute to a Coverdell ESA. Since 2002, organizations, such as corporations, have also been permitted to invest in a Coverdell ESA. Contributions can be made by individuals with modified adjusted gross income of less than $110,000. For a couple filing a joint return, that amount is $220,000.

How can Coverdell ESA withdrawals be used?

Coverdell ESA withdrawals can be used to pay for qualified education expenses at elementary and secondary schools (K-12), including public, private, or religious schools, as well as any college, university, vocational school, or other postsecondary educational institution eligible to participate in a student aid program administered by the Department of Education. This includes virtually all accredited, public, nonprofit, and private postsecondary institutions.

What expenses are covered by Coverdell ESAs?

Coverdell ESAs can be used only to pay for qualified education expenses, such as tuition and fees, the cost of books, supplies and other equipment, and in some situations the cost of room and board. Qualified elementary and secondary school expenses include expenses for tuition, fees, and academic tutoring; special needs services in the case of a special needs beneficiary; books; supplies and other equipment; room and board; uniforms; transportation; extended day programs; and computer technology, equipment, and Internet access.

When can Coverdell ESA assets be withdrawn?

Coverdell ESA distributions may be made at any time. As long as the distribution is applied to payment of the qualified education expenses of the designated beneficiary, it will generally not be considered taxable income for the child. Coverdell ESA assets generally must be used before the student reaches the age of 30 years. At that point, the funds will be distributed to, and generally considered taxable income of, the student, with the exception of special needs children who are not subject to any age restrictions. To avoid this, the funds in a Coverdell ESA may be rolled over into a Coverdell ESA for another eligible family member before the primary beneficiary reaches age 30.

What is the tax treatment of Coverdell ESA distributions not used for qualified education expenses?

The earnings portion of a Coverdell ESA distribution that is not considered to be for qualified education expenses will be included in the gross income of the child and an additional 10 percent IRS tax penalty may apply.

Where can I find more information on Coverdell ESAs and other education savings opportunities?

Many mutual fund company websites provide information on education savings programs.

Individuals seeking information on 529 savings plans may want to visit the website for the National Association of State Treasurers at www.collegesavings.org. This site includes an Investor Education section, which offers information on the two main types of education savings vehicles, educational resources for prospective investors, and links to other helpful education savings sites.

In addition, IRS Publication 970 summarizes tax benefits available for education.

May 2007