Coverdell Education Savings Account Explained

With education costs ever increasing, it's important to get a head start. The Coverdell Education Savings Account, or Coverdell ESA, can give you a head start saving money for college and your children's general education, while offering some attractive tax benefits as well.

Formerly known as an Education Individual Retirement Account, the Coverdell ESA does have some things in common with IRAs. Contributions are not tax-exempt, but interest is, as long as the funds are used for education. Account owners can choose from a variety of investment strategies, including stocks, bonds and mutual funds, and may make adjustments to these investments periodically.

A Coverdell ESA may be set up for anyone under the age of 18. Contributions may be made until the same age. All contributions must be in the form of cash, but cash contributions from corporations are permissible.

One of the most attractive aspects of the Coverdell ESA is that the proceeds can be used for any level of education. Unlike 529 plans that may only be used for college, Coverdell ESA funds may be withdrawn without penalty to use for elementary or secondary education as well. The money may be put toward tuition, fees, books, supplies and required equipment. Those who are enrolled at least half time may also use the funds to pay for room and board.

There are certain restrictions imposed on these account, however. One of the most important is the $2,000 yearly contribution limit per beneficiary. There is no limit to the number of Coverdell accounts that may be set up for one beneficiary, but contributions across all such accounts can still be no more than $2,000 per year. And contributors with an adjusted gross income of over $95,000 may not contribute the full amount.

Another thing important to remember is that all funds must be withdrawn by the beneficiary's 30th birthday. The only exception to this rule is for special-needs students, for whom there is no age limit. If the funds for a non-special needs student are not used by the time he turns 30, they must be rolled over into an ESA for another family member to avoid taxes and penalties.

It's also important to note that these accounts have an effect on financial aid eligibility, too. The effect is largest when the account is owned by a student who is not a dependent, but the account is also considered to a lesser extent if it is owned by a parent or a dependent student. Withdrawals may be limited if claiming a Hope Scholarship or Lifetime Learning tax credit in the same year.

A Coverdell ESA is great for saving for any level of education. While it may not pay for the entire cost of college, the benefits make it a good choice for most families. Using it in conjunction with a 529 plan or other investment vehicle enables you to save up a great deal of money.

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