A Beginner's Guide to the Coverdell ESA

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Parents, grandparents, and other family members looking to save for a child's college education may want to consider a Coverdell Education Savings Account (ESA). This account is a long-term investment tool that might be a good way to help you put money away every year as your child grows up.

Just like any investment, it is important to understand the finer details of this savings vehicle, and this beginner's guide is a perfect place to start. If you decide that you would like to investigate further, speak with your financial advisor to get the latest details and receive personalized help to determine if the Coverdell ESA is right for you.​

What Is a Coverdell ESA?

The Coverdell ESA was originally introduced in 1997 as the Education IRA. In 2001, Congress expanded its benefits and renamed it the Coverdell Education Savings Account (ESA).

The account allows up to $2,000 per year in after-tax contributions to be made in a child’s name. These contributions grow tax-deferred and may be withdrawn tax-free for qualified educational expenses.

If the money is not used by the time the child turns 30, it must be given to them or rolled over to a Coverdell ESA for another family member.

Ideal Investors for a Coverdell ESA

A Coverdell ESA is ideal for parents or grandparents who have some combination of the following factors:

  • You have multiple children with the hope that all will attend college.
  • You start planning for college early in the children’s lives.
  • You plan to save large amounts toward covering college costs.
  • Your children may attend private elementary or secondary schools.
  • You want a high level of flexibility with your investment choices.
  • You fall below the maximum income limits for contributors ($95,000 for single filers, $190,000 for married couples).

Potential Advantages

The primary advantage of a Coverdell ESA is that it allows for the tax-deferred growth of its assets, as well as tax-free distributions for qualified educational expenses.

Coverdell ESAs also allow for tax-free distributions to help pay for elementary, middle, and high school educational costs. This is not allowed in Section 529 plans.

Potential Disadvantages

The biggest disadvantage for parents and donors is the rule requiring you to either distribute the Coverdell ESA by the time the child turns 30 or roll it over to another child. This means that if there is still money in the account and the children either decide against going to college or do not need all the money, a parent may eventually have to hand it over to them.

What Are Your Investment Options?

Coverdell ESAs can be invested in individual stocks, bonds, CDs, or mutual funds. Coverdell ESAs are not permitted to directly own real estate, precious metals, collectibles, or partnerships in private businesses.

What Tax Benefits Can You Expect?

You won't receive any tax deduction for putting money into a Coverdell ESA. Contributions are made with after-tax dollars and will not lower your tax bill in the year you contribute.

The big tax benefit of the Coverdell ESA is that it allows for tax-deferred accumulation and tax-free withdrawals for qualified expenses. In other words, you do not have to pay tax on any of the annual growth of your original investment if the money is used for education.

What Are Eligible Expenses for a Coverdell ESA?

An ESA owner may take a tax-free distribution on behalf of the beneficiary for qualified educational expenses. In addition to college and graduate school, these expenses can be for elementary and secondary education (grades K-12).

The IRS has fairly liberal standards about what may be claimed as an educational expense, including:

  • Tuition, Room, and Board
  • Computers and Laptops (even if not required by the school)
  • Books and Supplies
  • Tutoring
  • Transportation

Can the Coverdell ESA Impact Federal Financial Aid Eligibility?

Coverdell ESAs may affect financial aid significantly, or not at all. It depends on who the “owner” of the account is. By definition, the owner is typically the person who sets up the account and not the person who is eventually going to college (they are the “designated beneficiary”).

  • If the child is both the owner and the designated beneficiary and is still considered a dependent of the parents, none of the assets are counted against financial aid.
  • If the child is both the owner and the designated beneficiary and is considered independent of the parents, 20% (this dropped from 35% in 2007) of the assets are counted against financial aid.
  • If the owner is a parent, then 5.64% of the assets are counted against financial aid.
  • If the owner is a grandparent, a member of the extended family, or an unrelated individual, it is argued that the assets do not count against financial aid at all. This is due to the fact that there is no place to report assets owned by people other than a parent or student on the FAFSA form.

An Important Note: Legislation in Congress can affect and change any of these general outlines in the future. That may include making the Coverdell ESA assets of the parents or changing any of the terms. Be sure to check with your financial advisor for the latest details and stay up to date on the developments if you decide to invest in a Coverdell ESA.


Any adult can establish a Coverdell ESA for any child under the age of 18. The child, or designated beneficiary, does not need to be related to the person establishing the account.

Contribution Rules

A child’s Coverdell ESA can accept contributions up until their 18th birthday unless the child is considered “special needs.” The maximum annual contribution allowed is $2,000 per designated beneficiary, not per adult contributor.

If a child has more than one Coverdell account (for example, one established by mom and dad and another by a grandparent), the total contributions for a given year may not exceed $2,000 between all accounts.

The full $2,000 contribution may only be made by individuals whose “modified adjusted gross income” (or MAGI) is below a certain dollar amount in the year they contribute. If their income is above this amount, but below the “ceiling,” they may make a partial contribution.

For taxpayers claiming a single, head of household, or married filing separately status:

  • $95,000 (MAGI) or less: The full $2,000 contribution is permitted.
  • $95,000 to $110,000 (MAGI): A partial contribution is permitted.
  • $110,000 (MAGI) or more: No contribution is permitted.

For taxpayers claiming a married filing jointly status:

  • $190,000 (MAGI) or less: The full $2,000 contribution is permitted.
  • $190,000 to $220,000 (MAGI): A partial contribution is permitted.
  • $220,000 or more: No contribution is permitted.

Contribution Deadline

Contributions to a Coverdell ESA for the previous year must be made by the contributor’s tax filing deadline, excluding extensions.

For example, you have until April 15, 2020, to make a contribution for your 2019 tax year even if you file an extension with the IRS.

Withdrawal Rules

There are no taxes or penalties on withdrawals made to fund educational expenses, as long as the withdrawal doesn’t exceed the actual amount of expenses. If excess funds are withdrawn, a portion will be subject to taxation and penalties.

Treatment of Unused Funds

If funds remain unused, they must be distributed to the named beneficiary on the account by 30 days after the designated beneficiary’s 30th birthday.

To avoid this, the IRS permits the funds to be transferred into another Coverdell ESA for someone related to the first beneficiary, who is under 30 years of age. Related parties include immediate family members of the original beneficiary, parents, cousins, aunts and uncles, and even in-laws.