Families can save on college and K-12 expenses with a Coverdell Education Savings Account (ESA), formerly known as Education IRAs.
Coverdell ESAs are less popular than 529 college savings plans, but have some advantages over these in elementary and secondary school savings.
But are these advantages so great that it is worth opening a Coverdell ESA? Read on to find out the pros and cons of Coverdell Education savings accounts and to help you decide.
Benefits of Coverdell Education Savings Accounts
Coverdell Education savings accounts have a few advantages that can be worth considering. Here are some of its most notable benefits.
More spending on qualified education
Like 529 plans, Coverdell ESAs provide tax-free distributions to pay for qualified educational expenses. However, Coverdell ESAs have a broader list of eligible issues than 529 plans and fewer restrictions.
While 529 plans can only be used to pay up to $ 10,000 per year in K-12 tuition and fees, Coverdell ESAs have no cap on K-12 training costs. Coverdell Education savings accounts can also be used to pay for things like academic tuition, special needs services, uniforms, and more.
The eligible institutions are the same for Coverdell ESAs and 529 plans. This includes all colleges that are entitled to state student aid under Title IV, and all elementary or secondary schools under state law, including home schools.
Greater choice of investments
Investors in a Coverdell ESA have more control over investments than investors in 529 plans. 529 plans are typically limited to a few dozen mutual funds selected by the plan administrator. Coverdell Education savings accounts can be invested in individual stocks and bonds. However, they cannot be invested in life insurance contracts.
Drawbacks of Coverdell Education Savings Accounts
Coverdell Education savings accounts are more restrictive than 529 plans in many ways.
Annual contribution limit
There is an annual contribution limit of $ 2,000 per beneficiary. This is a combined cap that applies to all contributions from all sources to all Coverdell ESAs of the beneficiary. 529 plans have no annual contribution limit other than the annual gift tax exclusion.
Excess contributions over $ 2,000 will be subject to a 6% excise penalty unless withdrawn by May 31st. Parents can find out about relatives’ excess contributions by receiving IRS Form 5498.
Taxpayers can offset the contributions made up to the due date in the federal income tax return, without renewals, against the contribution limit of the previous year.
Connected: 529 Plan contribution limits
Age limit of the beneficiary for contributions
Contributions to a Coverdell Education savings account must end when the beneficiary turns 18, except for beneficiaries with special needs.
Income limit of the contributors for contributions
There is an assessment ceiling. The contributor must have an adjusted gross income of less than $ 110,000 (single) or $ 220,000 (married enrollment together). The annual contribution limit starts at $ 95,000 (single) and $ 190,000 (married joint registration). These income limits are not adjusted for inflation.
There are workarounds for the income threshold. Parents can give the child the money and let the child contribute to Coverdell ESA. In contrast to an IRA, the child does not have to have an income. Corporations and trusts can also make contributions with no income limit.
Age limit of the beneficiary for distributions
The Coverdell Education savings account must be paid out in full by the beneficiary’s 30th birthday, except for beneficiaries with special needs. An alternative is to change the Coverdell ESA beneficiary to a family member of the current beneficiary if the new beneficiary is under 30 years of age.
Coverdell Education Savings Accounts have many of the same terms and conditions as 529 plans. Here is a short list:
Change of beneficiary
As with the 529 plans, the beneficiary of a Coverdell Education Savings Account can be changed to a family member of the beneficiary. However, the new beneficiary must be under 30 years of age.
Eligible family members include:
Spouses of any of the above members are also eligible to become new Coverdell ESA beneficiaries. The beneficiary’s family members also include first cousins, but not their spouses.
Rollover contributions are not subject to income limits or excise taxes. Rollover is also not subject to any contribution limits.
You can switch from a Coverdell ESA to a 529 plan, but not the other way around. The 529 plan must have the same beneficiary as the Coverdell ESA. As the beneficiary approaches the age limit of 30, a workaround is to convert the money to a 529 plan.
Only one rollover is allowed per 12 month period. However, you can make an unlimited number of trustee-to-trustee transfers. Rollovers must take place within 60 days if they are not carried out through a transfer from trustee to trustee.
Coverdell ESAs can be transferred to the beneficiary’s ex-spouse under a divorce judgment or separation agreement. Such a transfer is not taxable.
If you’re looking to save on elementary, intermediate, or advanced tuition fees, a Coverdell ESA can be a great choice. Unlike 529 plans, Coverdell Education savings accounts have no annual limits on tax-free withdrawals for K-12 expenses.
However, 529 plans are likely to be more attractive to college savers as they have practically no annual contribution limits. However, Coverdell ESA contributions cannot exceed $ 2,000 per year per beneficiary. That’s pretty limiting when you’re trying to save on expensive tuition fees.
Not sure which account to choose yet? Find out more about your various educational savings account options here >>>