Coverdell Education Savings Accounts: What You Need To Know

sasirin pamai / iStock.com

Commitment to Our Readers

GOBankingRates' editorial team is committed to bringing you unbiased reviews and information. We use data-driven methodologies to evaluate financial products and services - our reviews and ratings are not influenced by advertisers. You can read more about our editorial guidelines and our products and services review methodology.

20 Years
Helping You Live Richer

Reviewed
by Experts

Trusted by
Millions of Readers

Coverdell Education Savings Accounts, or ESAs, are tax-advantaged investment accounts designed to help families save for future educational expenses.

Unlike 529 plans that primarily focus on college costs, Coverdell ESAs offer a wider range of qualified expenses, including K-12 tuition, fees, books, supplies and even certain qualified special needs services.

Who Can Open and Contribute?

Anyone can open a Coverdell Education Savings Account for a beneficiary, as long as the beneficiary is under 18. 

However, there are income limits for the person who contributes. 

How Much Can You Contribute?

One beneficiary cannot receive more than $2,000 per year. That means that even if multiple people have opened up Coverdell ESAs for one person, they still can’t receive more than $2,000 in all of their accounts combined.

What Expenses Are Covered?

Many types of expenses can be covered by this account, including:

• Tuition and fees for elementary, secondary and post-secondary institutions (public, private and religious)
• Books, supplies and equipment necessary for enrollment or attendance
• Special needs services
• Room and board (with certain limits) for students enrolled at least half-time 
• Computers and peripheral equipment
• Internet access, and related services used primarily by the beneficiary while they are enrolled in school
• Academic tutoring

What Are the Tax Benefits?

You can’t deduct Coverdell ESA contributions from your taxes. However, the contributions grow tax-free in the account and aren’t subject to capital gains tax.The beneficiary can receive tax-free distributions as long as they don’t take out more than their adjusted qualified educational expenses. 

To determine your adjusted qualified educational expenses, add up:

• Scholarships and grants after taxes
• Veterans educational assistance
• Pell grants after taxes
• Employer-provided educational assistance

If the beneficiary spends more than that amount, they will be taxed on any withdrawals.

What Happens If You Go Over the Contribution Limit?

Make sure to keep track of how much money is being contributed to the account. If the account goes over the $2,000 limit in one year, the beneficiary has to pay a 6% tax on every dollar over the limit. 

You don’t have to pay this tax if the extra contributions are withdrawn by June 1 of that year.

What Do You Do With Leftover Coverdell ESA Funds?

If you finish school before you empty your Coverdell ESA accounts, the person who opened the account can roll it over to another person. 

They can also wait until the beneficiary has turned 30. At that point the IRS requires the account to be emptied within 30 days of the beneficiaries 30th birthday. 

If the beneficiary dies before their 30th birthday, the account needs to be emptied 30 days after their death.

Impact on Financial Aid

When a beneficiary’s financial aid is determined, Coverdell ESA’s are not considered. The account belongs to the person who opened it.

Any withdrawals aren’t considered income, so they won’t be factored into financial aid decisions either.

Coverdell ESA vs. 529 Plan

A 529 plan is another way to contribute to someone’s education expenses. However, there are a few differences. Generally, 529 plans are better for college expenses, while Coverdell ESA’s are better for education expenses before college.

A 529 plan:

• Has no income limit
• Can potentially let you contribute more than $2,000 each year
• Has different rules for leftover funds
• Can be an education savings plan or prepaid tuition plan
• Are mainly used for college expenses

If your income is too high to contribute to a Coverdell ESA or you’d like to contribute more than $2,000, consider a 529 plan. 

Tips to Maximize Your ESA

A beneficiary can get a lot of financial help from a Coverdell ESA, but overcontributing to the account or using the money on the wrong expenses can create a tax burden. 

If someone opened a Coverdell ESA for you:

• Keep track of every dollar you’re given. 
• Make sure you understand qualified expenses before you make a withdrawal
• Keep receipts for each expense
• If your account is overcontributed to, try to use the funds by the deadline.

Allison Hache contributed to the reporting of this article.

Share This Article: