Coverdell Savings Account
Formerly called the Education IRA, the Coverdell Education Savings Account (ESA) has been enhanced to include higher contribution limits. In addition, the definition of qualified education expenses has been expanded. "Coverdell Education Savings Accounts will not be taxable when distributions are used to pay for qualified education expenses."
A Coverdell Education Savings Account is a custodial account that is established for the purpose of paying qualified education expenses of a designated beneficiary of the account. A contributor is allowed to contribute up to $2000 per year per beneficiary. As long as the contributor’s income is not more than $220,000 (couples filing jointly) or $110,000 (single filing), you may contribute to a Coverdell Savings for a beneficiary (such as a child or grandchild) that is under the age of 18. If your income is above these limitations, you may be entitled to make a prorated contribution amount. You are also eligible to make separate contributions for different beneficiaries.
The income earned by or within Coverdell Education Savings Accounts will not be taxable when distributions are used to pay for qualified education expenses. Under the Economic Growth and Relief Reconciliation Act of 2001 (EGTRRA), distributions from a Coverdell Education Savings Account will be excluded from income tax (i.e. not subject to tax) to the extent that the distributions do not exceed the qualified education expenses incurred by the beneficiary of the account in the year of the distribution.
Contributions made to a Coverdell Savings are made with after-tax dollars so there is no tax deduction for contributions. The amount of educational expenses for which a distribution from a Coverdell ESA can be used and not be subject to the tax must be reduced by the amount of any qualified scholarship, educational assistance allowance, or payment that is excludable from the beneficiary’s gross income.
If a distribution is not used for qualified education expenses then the designated beneficiary will be liable to pay the 10% excise tax on that portion of the distribution that is taxable. The funds may be rolled over to another family member if the beneficiary decides not to use the funds for qualified education expense. All funds in the Coverdell Savings must be used by the time the beneficiary is 30 years of age.
Contributions for beneficiaries with special needs may be made after age 18 and the mandatory distribution age of 30 may be extended for a beneficiary with special needs.
A Shelby County State Bank IRA Specialist can give you more specific details on Coverdell Education Savings Accounts.