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What Is a Coverdell Education Savings Account?

Setting up a college savings account is a smart move to invest in education, whether it’s for yourself, a family member, or a friend.

There are different ways to save for higher education, some of which offer tax benefits. The best choice depends on personal needs and goals. In this blog about saving for college, we’ll take a closer look at Coverdell Education Savings Accounts.

What is a Coverdell ESA?

Coverdell Education Savings Account (ESA) is a tax-deferred trust or custodial account created by the US government to help families fund educational expenses for beneficiaries aged 18 or younger. The age restriction can be waived off for special needs beneficiaries. While it’s possible to establish more than one ESA for a single beneficiary, the annual maximum contribution for a single beneficiary is $2,000, and only families with income below a specific level are eligible.

Coverdell ESA offers tax-free investments and tax-free withdrawals to spend on qualified education expenses, including college expenses and certain K-12 purchases. Qualified elementary and secondary education expenses include books, supplies, equipment, and academic tutoring, among others.

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What are Qualified Expenses Coverdell?

Qualified expenses for a Coverdell Education Savings Account (ESA) refer to specific educational costs that can be paid for using funds from the ESA without incurring penalties or taxes. These expenses include tuition, fees, books, supplies, equipment, and certain room and board costs for eligible educational institutions from elementary through post-secondary levels.

How a Coverdell Education Savings Account (ESA) Works?

When it comes to opening a Coverdell education savings account, there are some rules you need to follow. These include:

Meeting Eligibility Criteria

To start a Coverdell ESA, you need to meet certain requirements set by the IRS. These conditions include:

  • The beneficiary of the account must be under 18 years old, unless they have special needs, in which case there might be exceptions.
  • The account must be clearly identified as a Coverdell ESA when you open it.
  • All the paperwork for opening the account needs to be in writing, as per IRS rules.

Understanding the Contribution Limits

You can have more than one Coverdell account for a beneficiary, but all contributions combined can’t exceed $2,000 per year. Similar to individual retirement accounts (IRAs), you can make your annual contribution to an ESA up until the tax filing deadline for that year.

There are income limits for opening a Coverdell account, based on your modified adjusted gross income (MAGI) and filing status. If you file jointly and your MAGI is under $190,000 per year (or $95,000 for single filers), you can contribute the full amount. The contribution limit decreases for those with a higher MAGI, and if it’s over $220,000 per year (or $110,000 for single filers), you’re not eligible to contribute to a Coverdell ESA.

Understanding Distribution

Beneficiaries can withdraw money from a Coverdell ESA tax-free for qualified educational expenses, such as tuition, books, tutoring, and sometimes transportation or housing.

Be aware that nonqualified distributions are taxable to the beneficiary, along with a 10% penalty. It’s important to understand what expenses qualify before making a withdrawal. If unsure, consulting a tax advisor is recommended to avoid costly mistakes.

The remaining funds in a Coverdell ESA must be distributed when the beneficiary turns 30 unless they have special needs. If the distribution isn’t for educational expenses, taxes and penalties apply. However, you can switch the beneficiary to another family member once a year.

How to Set Up a Coverdell ESA

Creating an ESA for your child is a simple process that can be done through a brokerage, financial institution, or directly with a mutual fund company. Once the ESA is set up in the child’s name, anyone can contribute to it as long as they follow a few rules:

  1. Annual Contributions: You can’t put more than $2,000 into your child’s ESA(s) each year. The child must be under 18 when you make the contribution, unless they’re a special-needs child.
  2. Contribution Limits: The maximum $2,000 contribution depends on your tax filing status and modified adjusted gross income (MAGI). Joint filers with a MAGI under $190,000 ($95,000 for single filers) can contribute up to the full amount. The limits decrease as MAGI increases, and contributions are completely phased out for joint filers with a MAGI of $220,000 or more ($110,000 for single filers), as shown in the table above.
  3. Use of Funds: The money in the ESA must be used for qualified educational expenses or transferred to another beneficiary before the child turns 30.
  4. Changing Beneficiaries: You’re allowed to change the beneficiary to another family member once a year.
  5. Contribution Deadline: You have until Tax Day of the following year to contribute for the previous year.

What Does a Coverdell ESA Cover?

A Coverdell ESA offers some flexibility regarding how you can use your funds without facing taxes.

When you withdraw money from a Coverdell ESA, you won’t pay taxes on it as long as you use it for qualified elementary, secondary, or higher education expenses. While a 529 plan mainly covers higher education costs, a Coverdell ESA also includes elementary and secondary education expenses, though there are some restrictions.

Moreover, you can use funds from a Coverdell ESA tax-free to cover expenses like high school tutoring. This feature can be particularly helpful for parents managing tuition fees at private high schools and similar expenses.

Here’s what you can use your Coverdell ESA funds for at primary, secondary, and higher education institutions:

  • Tuition
  • Mandatory fees
  • Books and supplies required for enrollment or attendance
  • Computers, equipment, and other technology necessary for enrollment or attendance

For more details on tax-free usage of Coverdell ESA distributions, you can refer to IRS Publication 970: Tax Benefits for Education. However, it’s important to stick to using funds only for “qualified” expenses. Otherwise, any withdrawals not meeting this criterion may be subject to income tax at your applicable rate, along with a 10% penalty. State taxes may also apply.

For personalized advice on managing Coverdell ESA withdrawals and understanding their tax implications, it’s wise to consult a certified financial advisor and tax professional. They can offer tailored guidance based on your specific situation and ensure compliance with tax laws.

Coverdell ESA Advantages and Disadvantages

Coverdell Education Savings Accounts (ESAs) provide a level of flexibility that sets them apart from other education savings options. They offer a variety of investment choices, including stocks, bonds, mutual funds, and even alternative assets like real estate, especially with self-directed Coverdell ESAs.

Unlike 529 plans, where investment options are usually predetermined, Coverdell ESAs give account holders more control over their investment strategies. Thanks to this, individuals have direct control over directing investments within the account. Additionally, Coverdell ESAs often allow a broader range of K-12 education expenses, offering more versatility than other savings vehicles such as 529 plans.

However, it’s important to consider some restrictions that come with Coverdell ESAs, particularly regarding contribution limits and withdrawal rules. These accounts have a maximum annual contribution limit of $2,000, and contributors can no longer add funds once the beneficiary turns 18. Furthermore, funds must be distributed by the time the beneficiary reaches 30, and there are no state tax benefits associated with Coverdell ESAs. Additionally, contributors must meet income limits to qualify for contributions.


  • Funds can be used for a wider range of K-12 expenses
  • Offers various investment options
  • Tax-free growth on investments


  • Maximum annual contribution limit of $2,000
  • Contributions stop after the beneficiary turns 18
  • Required distribution of funds once the beneficiary reaches 30
  • No state tax benefits
  • Contributors must meet income limits to qualify for contributions

Alternatives to a Coverdell ESA

  1. 529 Plan

    Considered a top choice by many, 529 plans let you save for education with potential tax breaks on contributions (depending on your state) and tax-free growth for qualified expenses. They offer more flexibility in how much you can contribute compared to Coverdell ESAs, and they cover a broader range of education costs.

  2. Roth IRA

    While not just for education savings, a Roth IRA lets your contributions grow tax-free and offers tax-free withdrawals in retirement if you follow the rules. This can free up other money you have to use for education expenses. There are limits on how much you can contribute and who qualifies to contribute based on income.

  3. Brokerage Account

    If you’re comfortable picking investments, a brokerage account gives you control over what you invest in, like stocks, bonds, or mutual funds. The money you earn typically gets taxed, but there aren’t any special tax benefits for education savings.

  4. High-Yield Savings Account

    This is a safe option for keeping your money easily accessible. These accounts offer better interest rates than regular savings accounts, but the growth won’t be as high as some other options. The interest you earn gets taxed as regular income.

Coverdell Education Savings Accounts vs. 529 Plans

SectionCoverdell Education Savings Account (ESA)529 Plan
Tax-free withdrawalsESAs allow tax-free withdrawals for qualified expenses covering education from kindergarten through college.529 Plans offer tax-free withdrawals for qualified expenses incurred during college. Additionally, up to $10,000 can be withdrawn tax-free for primary or secondary school tuition.
Investment optionsESAs typically offer a wide range of investment options, providing flexibility for contributors.529 Plans, in contrast, often have limited investment options.
Income eligibility limit for contributorsFor ESAs, annual contributions are capped at $2,000 for joint filers with a modified adjusted gross income (MAGI) up to $190,000. Contributions are gradually reduced for MAGI between $190,000 and $220,000, with incomes above $220,000 being ineligible.529 Plans do not have income eligibility limits for contributors.

Closing Thoughts

Choosing the right education savings plan can feel overwhelming, but with careful consideration of your goals and the options available, you can find the best fit for your child’s future. If you have questions about Coverdell ESAs or need help navigating the college savings options, SD Retirement Plans is here to help. Contact us today and let our experienced advisors guide you through the process.

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Who can make contributions to a Coverdell ESA?

Contributions to a Coverdell Education Savings Account are permitted from individuals whose MAGI is under the limit set for a particular tax year. Regardless of their adjusted gross income, organizations like companies and trusts are likewise eligible to make contributions.

What Happens to a Coverdell if the Child Doesn’t Go to College?

There are a few options if the beneficiary of a Coverdell ESA doesn’t use the funds for college:

  • Withdraw the funds: You can withdraw the money from the account, but any earnings on the contributions will be taxed as income and subject to a 10% penalty.
  • Change the beneficiary: You can name a new beneficiary to the ESA, as long as they are a family member and under 18 years old. You can only do this once a year.
  • Roll the funds over: If the beneficiary has special needs, you may be able to roll the funds into a special needs trust to maintain eligibility for government benefits.

Can we move the funds from my child’s ESA into a 529 plan?

Unfortunately, there is no direct rollover option to move funds from a Coverdell ESA to a 529 plan. However, you can withdraw the funds from the ESA (subject to taxes and penalties if not used for qualified education expenses) and then contribute them to a 529 plan.

If I want to move the assets in the ESA to a different financial institution, how do I accomplish this?

You can typically transfer a Coverdell ESA to a different financial institution by following their rollover procedures. This may involve completing a transfer request form and providing the new institution with the account details of your existing ESA.

Is there a limit to Coverdell ESA contributions?

Yes, the maximum annual contribution limit for a Coverdell ESA is $2,000 per beneficiary. There are also income limits for contributors.

Who can contribute to a Coverdell ESA?

Anyone can contribute to a Coverdell ESA for a beneficiary under 18 years old, as long as the total contributions from all sources don’t exceed the annual limit.

How can Coverdell ESA withdrawals be used?

Coverdell ESA withdrawals can be used tax-free for qualified education expenses. These expenses include tuition, fees, books, supplies, computers, and certain room and board costs. Qualified education expenses can be for elementary, secondary, or higher education.

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

Earnings on contributions withdrawn from a Coverdell ESA for non-qualified expenses are taxed as income and subject to a 10% penalty. The original contributions themselves can be withdrawn tax-free at any time.

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

Contributions to a Coverdell ESA are not tax-deductible (unlike some 529 plans). However, earnings on those contributions grow tax-free as long as they are used for qualified education expenses.

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