Saving for College Using ESAs

Plan for Your Child’s Education With Coverdell Educations Savings Accts

by Jennifer Case

The world of education investing can seem like a daunting labyrinth. But with some research and helpful guidelines, you can successfully traverse this maze and make well-informed decisions for financing your child’s education.

What is an ESA?

A Coverdell Educations Savings Account, referred to as an ESA, is an investment vehicle targeted at covering education expenses. An ESA allows you to make an annual non-deductible contribution to a specially-designated investment trust account. This account is not subject to federal income taxes as it grows, nor is it subject to such taxes when the time for withdrawal comes around. Detailed tax information pertaining to ESA accounts can be found on the Internal Revenue Service website.

The Benefits of an ESA

ESAs allow you to invest not only for college expenses, but for elementary and secondary school costs as well. These may include tuition, books and uniforms.

How to Establish an ESA

Not everyone is eligible to contribute to an ESA. The beneficiary of the ESA account must be under the age of 18 at the time of the contribution. The law allows contributions for individuals with special needs beyond age 18. Special needs beneficiaries are generally described as individuals with certain mental or physical impairments.

There is no requirement that the beneficiary has to be your child, so a relative or friend can make the contribution on your child’s behalf.

To be eligible to contribute to an ESA, your income must be below a certain level in the year of your contribution. Contributors must have less than $190,000 in modified adjusted gross income ($95,000 for single filers) in order to qualify for a full $2,000 contribution.

The next step is to decide where to establish the ESA. Any bank or other financial institution should be capable of serving as a custodian of an ESA. Your cash contribution can be invested in any qualifying investments available through that financial institution. This can include stocks, bonds, mutual funds, and certificates of deposit.

Important Rules to Know

There is no limit to the number of ESAs that you can establish for any one child (as long as the total contributions stay within the $2,000 limit).

The designated beneficiary of a Coverdell ESA can take a distribution at any time. Generally, the distributions are tax free if they are not more than the beneficiary’s adjusted qualified education expenses for the year. When a student is enrolled at an eligible postsecondary school, the savings account can be withdrawn to pay for qualified higher education expenses, so long as the beneficiary is enrolled at least half time.

If there are remaining funds in an ESA after a child completes his or her education, the amount remaining in the account may be withdrawn for the Designated Beneficiary and the Designated Beneficiary will be subject to federal income tax on that amount.

ESAs require planning for someone’s college education before they turn 18, but, if done properly, can great alleviate much of the economic stress of a college career.