To continue our discussion of higher education savings, today we’re going to talk about the Coverdell Education Savings Account (ESA). ESAs are similar to the 529 savings plan, but there are some important differences.
The ESA, called the Education IRA up until 2002, was created by the U.S. government for the sole purpose of funding educational expenses. It allows you to grow investment earnings tax-deferred as long as it is to be used for educational expenses. When the beneficiary is ready to make withdrawals for their education, then the distributions will also be tax-free (as long as they are used for education expenses).
How do they work?
Like 529 plans, ESAs can be established at brokerages and other financial institutions, but unlike the 529 plans, ESAs have a total maximum contribution per year for a single beneficiary: $2000. Also, Coverdell ESAs are only available to families who qualify under a certain income level (below $110,000 for an individual and below $220,000 for married couples filing jointly).
Beneficiaries of the ESA must be 18 years old or younger and the funds must be withdrawn completely (for education expenses only) before the beneficiary reaches age 30, or the account will be taxed and penalized. However, it is possible for the ESA beneficiary to be changed to another family member below the age of 30 without incurring the tax or penalty. This is helpful because another benefit to the ESA is that it allows for the funds to be used for elementary and secondary school costs as well. So, if you are the beneficiary of the ESA and you’re about to turn 30, you can change the beneficiary to your child. Also, the age restriction can be waived for beneficiaries with special needs.
More details
Another benefit of the ESA is that you can have greater control over your investments, similar to a traditional IRA. However, it’s possible your financial firm doesn’t even provide ESAs. Vanguard, T. Rowe Price, and Fidelity no longer offer them, according to savingforcollege.com.
While there are yearly limits on how much you can contribute to your ESA, you can also open a 529 plan for the same beneficiary. Also, you can transfer your ESA funds to a 529 plan if you decide you would rather do that, you just have to keep the beneficiary the same.
Things to remember
Something to keep in mind is that the contributions limit of $2,000 a year can severely restrict your education savings, which you’ll need the very most of to pay the extremely high cost of higher education.
It’s also important to remember that education savings accounts will affect your financial aid eligibility. A certain percentage of your account will be included in your Expected Family Contribution to pay for college.
Hopefully this article helped give you a better understanding of what options you have to save for your child or beneficiary’s future education expenses. For more on the financial industry, follow NEXT Financial, Inc. on Facebook and LinkedIn and subscribe to this blog on the right-hand side of the page.
https://www.investopedia.com/terms/c/coverdellesa.asp
https://www.savingforcollege.com/intro_to_esas/
https://www.savingforcollege.com/article/coverdell-esa-versus-529-plan?page=2