The Coverdell ESA “Education Savings Account”. Lost in the mix?

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The tax code is filled with tax breaks to offset the cost of education. This includes programs like the Lifetime Learning Credit, the American Opportunity Credit, the Saver’s Credit, student loan interest destructibility, and the on-again off-again Tuition Deduction. Lost in all these options is the long-standing Coverdell Education Savings Account (ESA). Is it worth considering in your educational funding mix?

Coverdell ESA defined

The Coverdell account is a savings account that can be set up for the benefit of a student. After-tax contributions of up to $2,000 per student are available in any given year until the student is age 18. As long as the funds pay for qualifying educational expenses, any earnings made on the contributions are tax-free. The funds must be used by the time the beneficiary reaches the age of 30. If not, the funds must be given to another qualified student or the account holder must pay the tax on the earnings.

Coverdell advantages

While many think there are better savings options than the Coverdell ESA, here are some of the benefits of the account versus the popular 529 College Savings Plan and other educational savings alternatives.

Investment flexibility. Similar to Roth IRAs, Coverdell ESA’s have tremendous investment flexibility. This includes investing in stocks, bonds, mutual funds and regular bank products. Each state’s program manager limits Investment options within a particular 529 college savings plan.

Institution flexibility. Unlike most other educational tax programs, Coverdell ESA funds may also be used to pay for qualified elementary school and high school expenses. Other programs restrict use to post-secondary programs.

Broad qualified expenses. In addition to tuition, fees, books and classroom supplies, qualified expenses also include room and board when there is at least ½ time enrollment.

Great fill-in. The Coverdell ESA can be used for qualified educational expenses not covered by other programs. Coverdell ESA funds can not used to pay an expense already covered by another benefit.

Rollover flexibility. You can roll over unused funds to other qualified students. These rollovers are usually made to younger siblings.

The downsides

Funding limits. Coverdell ESA contributions are limited versus 529 College savings programs. Here are the major differences;

  Coverdell ESA 529 College Savings Plan
Annual contribution $2,000 per student Fairly unlimited; generally
$14,000 per contributor
per beneficiary
Income phase-out
No contribution if income over:
$110,000 single
$220,000 joint
No income limits
to contribute funds
Age limits
Funding:   until age 18
Use:   until age 30
No age limits

Ownership. Coverdell ESA balances can impact the amount of financial aid your student may receive. Contribution formulas weigh a student’s assets more heavily than a parent’s when determining aid. In addition, when the Coverdell ESA beneficiary reaches the age of 18, the funds are legally theirs. This lack of control means the funds might not be used for education. The same does not occur with the custodial nature of 529 Savings plans. Rollover strategies may be used to limit some of this risk.

Complicated planning. Given the age, limited annual contribution, and income limitations, a Coverdell ESA can make educational tax planning more complex. The lower account balance may make this exercise not worth the effort.

Is a Coverdell ESA an option worthy of your consideration? Perhaps. More important is starting your educational savings accounts early enough to benefit from earnings growth over time.