Coverdell education savings accounts: How they work and where to get one

Young child playing in the yard with her grandfather, her mother and grandmother looking on while they discuss setting up an education savings accountImage: Young child playing in the yard with her grandfather, her mother and grandmother looking on while they discuss setting up an education savings account

In a Nutshell

If you want to help pay for your child’s education expenses, consider opening a Coverdell education savings account. Coverdell ESAs typically let you contribute up to $2,000 per year for qualified education expenses, helping you offset education costs down the line.
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National student debt is at an all-time high, with tuition and fees for a single year at a private four-year college costing an average of $36,880 in 2019–2020, according to the College Board.

Getting a degree can be expensive, but you can help your child prepare for college financially — and possibly minimize their debt — by contributing to a college savings plan like a Coverdell education savings account, or ESA.

Investing in your child’s education with a Coverdell ESA has some advantages, including preferential tax treatment and the flexibility to use the money to pay for elementary or secondary school.

Find out how Coverdell education savings accounts work and how they compare to other popular college savings plans.

What’s a Coverdell education savings account, and how does it work?

A Coverdell ESA is a tax-deferred account that lets you save for a child’s education. Because it’s tax deferred, you won’t have to face any potential taxes on the funds until they’re distributed (and if the distributions are less than or equal to the qualified educational expenses for the given year, you won’t owe taxes on them at all).

There’s a cap on how much you can contribute each year. And you’ll have to designate a beneficiary who is younger than 18 or has special needs.

Let’s take a look at how Coverdell education savings accounts work by answering some common questions.

Who can contribute, and what is the contribution limit?

If you have a modified adjusted gross income of less than $110,000 ($220,000 for couples filing a joint tax return), you may be able to contribute to a Coverdell ESA. Parents, grandparents and even family friends can make contributions toward the child’s education, as long as they meet those income thresholds.

Organizations, including trusts and corporations, can contribute too, according to the IRS.

The annual contribution limit is typically $2,000 per year for each designated beneficiary, though the limit could be reduced depending on your income.

But it’s important to know that the total contribution limit is per beneficiary rather than per account. So if a parent, grandparent and aunt all open separate Coverdell ESAs for the same child, the total contributions to all three accounts combined can’t be more than $2,000 per year (assuming each contributor meets applicable income requirements).

And once the beneficiary turns 18, you can’t make any more contributions to the Coverdell account, unless the beneficiary has special needs.

What expenses can a Coverdell education savings account pay for?

A Coverdell ESA can be used to pay for qualified educational expenses at an “eligible educational institution.” That includes elementary and secondary schools — ESAs aren’t just for higher education.

For elementary school or secondary school, the ESA can pay for …

  • Tuition and fees
  • Books, supplies and equipment
  • Academic tutoring
  • Special needs services (for beneficiaries with special needs)
  • Computers and computer equipment

And it’ll cover the following items, if the elementary or secondary school requires them (even if the school provides it at the student’s expense):

  • Uniforms
  • Room and board
  • Transportation
  • Supplementary items and services, including extended day programs

For students attending a college, university or vocational school, an ESA can be used for …

  • Tuition and fees
  • Books, supplies and equipment
  • Special needs services (for beneficiaries with special needs at an eligible school)
  • Expenses for room and board for students enrolled in school at least half-time
  • Computer and computer software

When do funds have to be withdrawn?

Any assets left in the Coverdell account must be distributed by the time the designated beneficiary turns 30 — unless the beneficiary has special needs. If the beneficiary dies, the remaining assets must be distributed within 30 days of their death.

What if the beneficiary doesn’t go to college?

If the designated beneficiary decides not to go to college, you may be able to transfer the account to a family member with no tax consequences, depending on the age of the beneficiary, among other things.

Where can I open an education savings account?

You can open a Coverdell ESA at some banks, brokerage firms or mutual fund companies. As part of the account, you may be able to opt for certain investment products. Here are some examples.

  • Charles Schwab: Schwab has no account minimums, making it simple to start saving.
  • TD Ameritrade: With TD Ameritrade, there are no account minimums. You can invest in stocks, bonds and mutual funds.
  • Wells Fargo: You can open a Coverdell ESA with Wells Fargo, but the minimum investment could range from $0 to $100,000, depending on the account.

What is the difference between an education savings account and a 529 account?

If you’re saving for a child’s education, you may also decide to open a 529 plan, also known as a qualified tuition program, which is on our list of the best college savings plans.

If you’re trying to compare these accounts, consider these differences.

  • Income restrictions — Coverdells have an income threshold to be eligible to contribute. But 529 plans have no income restrictions for individuals.
  • Contribution limits — Unlike Coverdell ESAs, 529 plans don’t have a set contribution limit either. Instead, the IRS says that the contributions to a 529 can’t be more than the amount necessary to pay for qualified education expenses. Some states have different limits though, so it’s best to check on the plan you want to open.
  • Potential uses — 529 plan distributions can be used to pay for qualified postsecondary education expenses, like tuition and fees. But if you want to use the money for elementary or secondary school, there are some limitations. For example, you can withdraw only up to $10,000 per year to pay for tuition (and only tuition) for elementary or secondary school. Compared with a Coverdell ESA, many more categories of expenses can be covered. A Coverdell ESA may also allow you to withdraw more per year for qualified educational expenses for private elementary, middle or high school.
  • Taxes — Qualified contributions to both Coverdell ESAs and 529 plans are tax deferred and not deductible on your federal income taxes. And the qualified distributions for both savings plans are tax exempt as long as you use them on qualified expenses (otherwise they’re subject to a 10% penalty).

If you want to maximize your savings, you can open both a Coverdell ESA and a 529 plan. You can contribute to both account types in the same year for the same designated beneficiary (whereas, multiple accounts of the same type would be limited).

What’s next?

If you’re not sure whether a Coverdell education savings account is the right option for you, consider these three questions.

  • How much do you plan on contributing per year? Look at your budget and think about what’s realistic from a savings perspective. If you can contribute up to $2,000 per year, a Coverdell ESA can be a smart option if you meet the income requirements. If you want to contribute more than that, a 529 plan has no annual contribution limit, only lifetime account balance limits that may vary by state.
  • Will you send your child to a private elementary, middle or high school? If you decide to send your child to a private elementary or high school — and are looking to cover expenses other than just tuition — a Coverdell ESA may be the better option. That’s because 529s only allow for tuition as a qualified expense for elementary or secondary school.
  • What is your income? Coverdell ESAs have income restrictions. If your MAGI is more than $110,000 as an individual or $220,000 for joint filers, your contribution maximum will be lower than $2,000 and will gradually phase out.

Whichever college savings account you decide on, try to invest early — even if it’s only a little. Starting while your child is young gives your money more time to grow (tax-free!) with compound interest and market fluctuations. You may also want to consult a financial adviser to see what’s best for your situation.

About the author: Kat Tretina is a personal finance writer with a master’s degree in communication studies from West Chester University of Pennsylvania. Obsessed with her many side hustles, she focuses on helping people pay down their … Read more.