Originally created 03/06/02

Coverdell education saving account offers tax-free savings



The Coverdell Education Savings Account is an incentive to help parents and students save for education. Up to $2,000 may be contributed to a child's Coverdell ESA each year, starting in 2002; the limit was $500 before this year. Earnings on contributions will be distributed tax free, provided that they are used to pay the beneficiary's elementary or secondary school or college education expenses.

Any individual who meets adjusted gross income (AGI) requirements can make a non-deductible contribution on behalf of a child under the age of 18. The AGI requirements are $95,000 for single taxpayers and $190,000 for married taxpayers. The $2,000 annual contribution limit is phased out for single taxpayers with AGI of $95,000 to $110,000 and for joint filers with AGI of $190,000 to $220,000.

While a child may be the beneficiary of any number of Coverdell ESAs, the total contributions for the child during any tax year cannot exceed $2,000.

Starting with the 2002 tax year, contributions to a Coverdell ESA may be made until the due date of the contributor's return, without extensions. Note that this does not apply to contributions for 2001, which must have been made by last December 31.

Distributions are tax-free as long as they are used for qualified education expenses, such as tuition, books, fees, room and board, etc. This income exclusion is not available for any expenses for which the Hope credit or the lifetime learning credit is claimed for that student. If the distribution exceeds education expenses, a portion will be taxable to the beneficiary and will be subject to a 10% tax penalty. Exceptions to the penalty include death, disability or if the beneficiary receives a qualified scholarship.

If there is a balance in the Coverdell ESA at the time the beneficiary reaches 30 years old, it must be distributed within 30 days. A portion representing earnings on the account will be taxable and subject to a 10% penalty. The beneficiary may avoid this tax and penalty by rolling over the full balance to another Coverdell ESA for another family member.

For more information, check out IRS Publication 970, "Tax Benefits for Higher Education." It's available on the IRS Web site at www.irs.gov through the "Forms and Publications Finder," or by calling toll free 1-800-TAX-FORM (1-800-829-3676).