What is a Coverdell Education Savings Account?

What is a Coverdell Education Savings Account or ESA? The Coverdell plan was originally named the Education Ira and is similar to a Roth IRA or 529 savings plan. The name was changed to Coverdell in 2002. Before 2002 the limit to contributions was $500 per year. Not especially beneficial and this has now been raised to $2000 per year per beneficiary. The similarities to the 529 plan are that plan earnings are tax free and withdrawals for qualified education expenses are tax free at the Federal tax level. Most states also follow Federal rules regarding the taxes on this plan.

A benefit of the Coverdell plan is that plan contributions and proceeds could be used towards primary and secondary education expenses. Unfortunately, unless Congress takes action on the plan, lower education expenses will not be included after 2010. The contribution limit will also be reduced back to $500 per year.

There are quite a few differences between the Coverdell savings plan and a 529 savings plan. Contributions may not be made into a Coverdell plan after the beneficiary reaches the age of 18. All account funds must be used by the time the beneficiary reaches the age of 30 or the account may be subject to taxes and penalties.

There may be more than one Coverdell plan established for one beneficiary, however the maximum total contributions are still limited to $2000. If total contributions exceed $2000 penalties can be applied. It is also a bit tricky to combine Coverdell disbursements and any Hope or Lifetime Learning credits. The tax law will not allow you to claim multiple deductions for the same expenses.

Another major difference between a Coverdell account and a 529 plan is the ownership of the plan. With a Coverdell plan, the beneficiary ends up as being the plan owner. The value of the account can not be reverted to the person that established the account. If the funds are not used by the time the beneficiary turns 30, the account will be turned over to the beneficiary. At that time taxes and or penalties will apply. Rules for establishing the "responsible adult party" as the trustee or custodian will vary by the institution issuing the Coverdell plan. The responsible party may change the beneficiary of the plan during the plan course but rules for this vary and need to be established at the time the plan is started.

As with any investment account through research should be done beforehand and with the Coverdell Savings account it would be highly recommended as rules and end ownership of the plan vary from the 529 savings plans.