Coverdell Education Savings Account (ESA): How They Work

What Is a Coverdell Education Savings Account (ESA)?

A Coverdell Education Savings Account (ESA) is a trust account created by the U.S. government to assist families in funding educational expenses for beneficiaries who must be under the age of 18 when the account is established. The age restriction may be waived for special needs beneficiaries. While more than one ESA can be set up for a single beneficiary, the total maximum contribution per year for any single beneficiary is $2,000.

Key Takeaways

  • Coverdell funds can be used to pay for a wide variety of expenses for young people attending eligible schools. 
  • Coverdell funds must be used by the time a student is age 30 or taxes, fees, and penalties will accompany withdrawals. 
  • Total family member contributions to a Coverdell Education Saving Account are limited to $2,000 a year. 
  • Coverdell accounts are similar to 529 plans; however, for elementary and secondary school, Coverdell funds are allowed for other school expenses.

How a Coverdell Education Savings Account (ESA) Works

Formerly called an education IRA, the ESA allows families to increase investment earnings as long as the funds are used for educational purposes. When the contributions are distributed, they are tax-free assuming they are less than the account holder's annual adjusted qualified education expenses, including tuition, books, equipment, special needs services, and even academic tutoring. ESA account funds can be used for primary and secondary schools (grades K–12) as well as higher education.

If distributions are higher than the expenses, the gains are taxed at the account holder's rate, rather than the contributor's rate, which is typically higher. The Coverdell ESA is restricted to families below a certain income level based on their adjusted gross income (AGI). The AGI requirements are $95,000 or below for single taxpayers and $190,000 or below for married taxpayers for the full $2,000 contribution limit. The contribution limit is lower for higher earners and is phased out for single taxpayers with an AGI of $110,000 or more and for joint filers with an AGI of $220,000 or more.

Coverdell Education Savings Accounts vs. 529 Plans

ESAs may be established at brokerages and other financial institutions. These accounts are comparable to the 529 tax-free college savings plan. It is permissible to have a 529 plan as well as an ESA for the same beneficiary’s education expenses. However, there is no annual limit on the amount that may be deposited into a 529 plan.

Upon the beneficiary reaching age 30, any remaining funds in the ESA must be disbursed, unlike a 529 plan. The exception to this rule is if the beneficiary of the ESA qualifies as a special needs beneficiary.

529 plans can be used to pay off up to $10,000 in student loans and to pay for qualified expenses related to apprenticeship programs approved by the U.S. Department of Labor. There are no restrictions on the income level of the contributors to a 529 plan; however, fees may apply to 529 accounts and the investment has no guaranteed returns.

Corporations and trusts may make contributions to an ESA without the restriction on adjusted gross income.

What Is the Difference Between a 529 and a Coverdell?

The difference between a 529 and a Coverdell for elementary and secondary schools is that a 529 can only be used for tuition, while a Coverdell can pay for tuition and other school expenses.

How Much Can You Contribute to a Coverdell Account?

The annual contribution limit for a Coverdell account is $2,000 per beneficiary. This is for single taxpayers with an AGI of $95,000 and below as well as joint taxpayers with an AGI of $190,000 or below. Above these AGI levels, the contribution amount is reduced and completely phased out for single taxpayers with an AGI of $110,000 or more and joint taxpayers with an AGI of $220,000 or more.

What Happens to a Coverdell if the Child Doesn't Go to College?

If the child doesn't go to college and doesn't use the money by the time they are 30, the child (beneficiary) will have the amount distributed to them and will be taxed on the amount.

The Bottom Line

The Coverdell Education Savings Account was created to help pay for educational expenses for qualified families. The account must be established before the beneficiary turns 18. The maximum annual contribution is $2,000 and must be used by the time the beneficiary is 30 years old.

Correction—April 28, 2023: A previous version of this article incorrectly described the Coverdell Education Savings Account as a tax-deferred account instead of a tax-free account until the beneficiary reaches age 30.

Article Sources
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  1. Internal Revenue Service. "Topic No. 310 Coverdell Education Savings Accounts."

  2. Internal Revenue Service. "Publication 970, Tax Benefits for Education," Pages 38-40.

  3. Internal Revenue Service. "Publication 970, Tax Benefits for Education," Page 45.

  4. Internal Revenue Service. "IRS Tax Tip 2003-38. Coverdell Education Savings Account Can Make Education Costs Less Taxing."

  5. Internal Revenue Service. "Topic No. 313 Qualified Tuition Programs (QTPs)."

  6. U.S. Congress. "H.R.1994 - Setting Every Community Up for Retirement Enhancement Act of 2019," Title III: Sec. 302.

  7. Financial Industry Regulatory Authority. "Mutual Funds - Fees and Expenses."

  8. Financial Industry Regulatory Authority. "Mutual Funds: Risks."

  9. Investment Company Institute. "Coverdell Education Savings Accounts: FAQs."

  10. Internal Revenue Service. "Publication 970, Tax Benefits for Education," Pages 46–47, 51.

  11. Internal Revenue Service. "Publication 970, Tax Benefits for Education," Pages 39–40, 51.

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