What Is a Coverdell Education Savings Account?
Many families dream of saving to send a child to college. A Coverdell IRA or Education Savings Account (ESA) provides a simple way to start putting away money today.
A Coverdell Education Savings Account (CESA) is a flexible investment tool designed to help you build a lump sum to fund the education of your child or grandchild. You can open a CESA for any child and invest up to $2,000 a year. When needed, savings can be used tax-free to help fund a wide range of school or college education expenses.
Unlike other college savings options, Coverdell ESA rules allow more flexibility in how your money is invested and also gives you more choice in how you use the money when the time is right. Let’s take a closer look.
How Does a CESA Work?
CESAs used to be called education IRAs. They are named after Senator Paul Coverdell, who put forward the original legislation creating them. They combine the tax advantages of 529 college saving plans with the flexibility of a traditional individual retirement account (IRA).
A CESA can be set up on behalf of any child under 18 and allows up to $2,000 in annual cash contributions per child, provided the contributors meet certain income requirements. Contributions grow tax-free until needed.
Funds can also be withdrawn tax-free at any time before the beneficiary turns 30, provided they are spent on qualifying schooling or college education expenses.
CESAs are a popular choice with families who want more flexibility in how their education savings can be spent than that offered by 529 college savings plans. And, because it’s possible to change the beneficiary of the fund, they are a good choice for families who want to be able to support the educational aspirations of more than one child.
That said, CESAs come with some significant restrictions about how contributions can be made and withdrawals used:
- Contributions are capped at $2,000 a year
- Contributions are not tax deductible
- Funds must be used by the time the beneficiary turns 30
- Funds cannot be used to repay student loans
Let’s take a closer look at some of the specific rules governing CESAs.
Eligibility
A CESA can be established by anyone for any beneficiary under the age of 18. Most people open them on behalf of a child or grandchild. When opening a CESA, it’s important to bear in mind that only those earning below $95,000 a year (or $195,000 filing jointly) are able to contribute to the maximum $2,000 a year limit.
Those earning more than $110,000 or $220,000, respectively, cannot contribute at all. You do not need to be employed to contribute.
Contributions
Contributions to CESAs are not tax-deductible and are capped at $2,000 from all contributors. If you think you or your family are likely to be able to regularly contribute more than $2,000 a year, you should consider a 529 college savings plan.
As a “tax-deferred” investment, once in the CESA, your money will continue to grow tax-free. Unlike 529 plans, however, CESAs can be set up to invest in a wide range of investment options, including stocks, bonds, mutual funds, or money market accounts.
Withdrawals
Withdrawals are made in the form of distributions to the beneficiary. Provided these are used for a qualifying education expense, these distributions are tax-free.
CESA funding is more flexible in the type of qualifying educational expenses it can cover. This includes qualified spending on any education from kindergarten through to college, including:
- Tuition, room, and board
- Transportation
- Books and supplies
- Computers or laptops
- Extra tutoring
529 plans allow only $10,000 in spending on primary and secondary education, only fund computers or laptops required by schools, and do not fund transportation costs. Unlike CESAs, however, 529 funds can be used to pay off student loans.
Non-Qualified Expenses
If CESA withdrawals are used for non-qualified expenses, the amount will be taxed as normal income plus an additional 10% fee.
Unused Funds
CESA funds must be spent by the time the beneficiary turns 30. Money remaining in the account after this time is automatically distributed to the beneficiary and becomes subject to taxation, plus the same 10% tax penalty.
The owner of a CESA is also able to change the beneficiary of the account once a year, allowing unused funds to be directed to another child. While 529 plans don’t have an upper age limit, it’s not possible to change a beneficiary once it is created.
CESAs and Special Needs
CESAs are also allowed to be set up to benefit individuals with certain special needs, in which case the age limits for both establishing the CESA and making use of any funds are waived.
Let Jeanne D’Arc Help You Plan for the Future
A Jeanne d’Arc CESA is a simple, affordable, and flexible way to help fund a wide range of educational needs for your child or children. Major advantages of a CESA include:
- Tax-free withdrawals
- Flexible qualifying expenses
- The whole family can contribute
- You can contribute up to $2,000 per year
While CESAs come in many shapes and forms, a Jeanne d’Arc CESA is easy to open and functions much like a traditional IRA. With a solid investment approach already in place, we’re ready to help you:
- Check your criteria: Your child must be under 18 to open an account and you need to have plans to use the funds for education.
- Join our Credit Union by opening a regular savings account with a deposit of just $5.
- Open your CESA and start making contributions!
With regular contributions from you and other family members, you’ll be surprised how fast your balance grows. A Jeanne d’Arc Coverdell Education Savings Account means more saving flexibility today and more education options for your children tomorrow.
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