Coverdell IRA

Give your child the gift of education

Seeing a child work toward a college degree is a parent's dream.  But with rapidly excalating costs of higher education, this dream can become a financial nightmare.  A Coverdell Educational Savings Account (ESA) can help parents sleep at night.  The main benefits of a Coverdell ESA include:

  • Unlike state 529 plans, Coverdell ESAs can be used to pay for qualified elementary and secondary education expenses.
  • Earnings grow tax-free if distributions are used for qualified education expenses.

Below are some frequently asked questions concerning Coverdell IRA accounts

Q

 

How do I open a Coverdell ESA?

A.

 

Complete the Coverdell ESA application and return to the Credit Union.

Q.

 

What is a Coverdell ESA IRA?

A.

 

The Taxpayer Relief Act of 1997 created the Education IRA, now known as the Coverdell ESA.  Its sole purpose is to help you pay for your child’s education expenses, such as tuition, fees, books, supplies, equipment, and in some cases, room and board and computers.  These options were improved by the Economic Growth and Tax Relief Reconciliation Act of 2001.

Q.

 

How does a Coverdell ESA  work?

A.

 

Unlike traditional IRAs, contributions to a Coverdell ESA are never tax-deductible.  However, a Coverdell ESA offers you the potential for tax-free withdrawals – including earnings.

Q.

 

What is the most I can contribute to a Coverdell ESA?

A.

 

The total contributions each year to a child’s Coverdell ESA cannot exceed $2,000.  If you’re eligible, you can contribute the full amount for each child.  For example, if you have three children and each has his or her own Coverdell ESA, you can contribute $6,000 ($2,000 to each ESA).

Q.

 

Who is eligible to open and contribute the full amount to a Coverdell ESA?

A.

 

You can contribute the full amount if you are a:

  • Single filer with modified adjusted gross income (MAGI) up to $95,000

  • Joint filer with MAGI up to $190,000

Q.

 

How long can I contribute to the account?

A.

 

You can make contributions to a child’s Coverdell ESA until he or she reaches the age of 18.  This age limit does not apply to special needs beneficiaries.  This is a person who requires additional time to complete his or her education because of a physical, mental or emotional condition (including a learning disability).

Q.

 

As a parent am I the only one who can open and contribute to a Coverdell ESA for my child?

A.

 

No.  Anybody who meets the income requirements can open and contribute to your child’s Coverdell ESA.  This includes grandparents, aunts and uncles, family friends and anyone else who wants to pitch in to your child’s education fund.  Corporations, tax-exempt organizations and other entities can also make Coverdell ESA contributions, and there are no income limits on these contributors.  However, the total annual contributions to all Coverdell ESAs for each child can’t exceed $2,000.

Q.

 

Who controls the account?

A.

 

Every Coverdell ESA must have one, and only one, “responsible individual” to oversee the account.  This person decides when funds will be withdrawn and if and when funds will be rolled over to the Coverdell ESA of a family member.  You can be the “responsible individual” as long as you are a parent or legal guardian of the child.  The child can serve as the responsible individual after becoming an adult.

Q.

 

When can I withdraw the funds from a Coverdell ESA?

A.

 

As the responsible individual, you can withdraw funds at any time.  However, to avoid tax consequences from the withdrawal, you must use the funds to pay for qualified education expenses for your child (the ESA’s designated beneficiary) before he or she reaches age 30 (except the age 30 limit does not apply to a special needs beneficiary).

Q.

 

What educational expenses are considered to be “qualified”?

A.

 

Qualified expenses include tuition, fees, books, and equipment required for enrollment or attendance at nearly any post-secondary educational institution (public, nonprofit or proprietary).  Certain room and board expenses also may qualify.  Qualified expenses also include these same expenses for elementary and secondary education, and the purchase of computer technology or equipment that is used by the beneficiary and the beneficiary’s family while the beneficiary is in school.

Q.

 

What happens if my child doesn’t use the funds?

A.

 

If you child (the designated beneficiary of the ESA) decides not to go to college or leaves school before all the funds are withdrawn, you can roll unused funds into the Coverdell ESA of another child in your family.  The beneficiary of the Coverdell ESA who receives the unused funds must be under the age of 30 (except that the age 30 limit does not apply to a special needs beneficiary).

Q.

 

What if my child earns an academic scholarship and the tuition is waived?

A.

 

The amount of scholarship money your child receives is deducted from the allowable expenses for the Coverdell ESA.  For example, if qualified expenses total $6,000 and your child receives a scholarship for $3,000, you can make a qualified withdrawal of $3,000 from the Coverdell ESA. 

Q.

 

How does the Coverdell ESA affect other education savings incentives?

A.

 

Contributions can be made on behalf of the same child to both a Coverdell ESA and a qualified state 529 plan.  A person can also receive tax-free distributions from a Coverdell ESA in the same year he or she claims the Lifetime Learning or HOPE Scholarship tax credits, but the same expenses cannot be used for more than one of these tax benefits.

Q.

 

Don’t traditional and Roth IRAs allow me to withdraw funds for education expenses?

A.

 

Traditional and Roth IRAs do offer penalty-free withdrawals for higher-education expenses, but you may still need to pay taxes on those withdrawals.  In contrast, withdrawals from a Coverdell ESA are both tax-free and penalty-free if used for qualified education expenses.

Not intended as tax advice.  Please consult a tax professional.