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Do Coverdell ESAs Deserve Another Look?
The Coverdell Education Savings Account (ESA) was first introduced to the general public as the Education IRA back in 1997. It is typically used to help save for a young child's or grandchild's college or graduate school education. Although contributions are never tax deductible-unlike the traditional IRA-the funds may accumulate and grow within the account without any current taxation. The named beneficiary of the account must be under the age of 18.
In addition, distributions for "qualified expenses" are exempt from income tax. This includes tuition, books, supplies and equipment required for enrollment as well as room and board for full-time students. The balance remaining in the account must be distributed by the time the beneficiary reaches age 30, but funds may be rolled over tax-free to another account for a younger beneficiary.
For years, the Coverdell ESA was viewed as "small potatoes," but the benefits have improved. Under the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), the maximum annual contribution was quadrupled from $500 to $2,000. Furthermore, the limits on the availability of contributions were loosened. Currently, allowable contributions are phased out for single filers with a modified adjusted gross income between $95,000 and $110,000; $190,000 and $220,000 for joint filers. Finally, the definition of qualified expenses was expanded to include education expenses paid to an elementary or secondary school even if the school is private. In other words, Coverdell ESAs are not just for college savings anymore.
With all of these changes in place, the Coverdell ESA may become a viable option for some parents and grandparents. If you have dismissed this tax-saving vehicle before, you might want to revisit the possibilities.