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Coverdell Educational Savings Accounts

Question:

I recently learned of Coverdell education savings accounts (ESA), and I am considering setting one up for my child. What are the parameters and benefits?

Answer:

This account is designed to help parents save money for the education of their children. The beneficiary for the account may be anyone less than 18 years of age, and the contributions must be designated for qualifying educational institutions that range from the elementary level through higher education. There is a $2,000 contribution limit per beneficiary per year.

The main benefit of a Coverdell ESA is the tax-free growth on contributions. Contributions are not deductible; however, the balance in the account grows tax-free and will not be taxed upon distribution if it does not exceed the beneficiary’s qualified educational expenses. Upon distribution, the amount in excess of educational expenses of the beneficiary is subject to taxation and will usually incur an additional 10% tax. An exception applies when the beneficiary has received a scholarship that reduces qualified educational expenses. Another benefit of a Coverdell ESA is that the money may be rolled over from one Coverdell account into another family member’s Coverdell account free of tax.

If your state offers a 529 plan deduction, you may want to consider this before a Coverdell ESA. For more on Coverdell ESAs, please read IRS Publication 970.

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