Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Coverdell Education Savings Account

What it is:

Formerly referred to as an Education IRA, a Coverdell Education Savings Account (or Coverdell ESA) is a tax-advantaged savings account intended to help parents and guardians prepare for the expense of their child’s education.

How it works (Example):

A Coverdell Education Savings Account may be opened on behalf of a minor under the age of 18. Contributions are set at a yearly maximum of $2,000 (per child) and are not tax deductible, nor can they come from pre-tax dollars. The savings account then grows tax-free until the time of distribution.

If the funds are used for educational-related expenses, including tuition, fees, required books, personal computers and/or room and board, the distribution is also tax free. If the distribution amount exceeds the cost of educational expenses or the funds are used for non-educational expenses, the earnings on the account will be considered as regular income and will be taxed accordingly, along with an additional tax of 10%.

Education expenses are not limited to college and university costs, and can include elementary and secondary school, vocational and other qualified post-secondary institutions, as well as higher education.

Contribution limits exist for taxpayers based on their Modified Adjusted Gross Income (MAGI). For single filers, the modified adjusted gross income limit is $110,000, and $220,000 for joint filers.

If the beneficiary does not redeem funds before the age of 30, the account must be distributed within 30 days or be subject to taxation. Taxes may be avoided, however, if the full balance is rolled over into a new Coverdell ESA for another family member.

Why it Matters:

The cost of education is high and continues to rise (particularly where private schools and colleges are concerned). ESAs provide parents and their children the opportunity to start saving for educational expenses when their children are still very young. This way, contributions invested in the account have more time to grow with the benefit of compounding interest.

InvestingAnswers Feature: College Tuition: 5 Ways to Save on Education Expenses

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