In 2002, the Education Individual Retirement Account was renamed the Coverdell Education Savings Account. The Coverdell ESA is a way for parents and interested parties to contribute to a tax-deferred savings account for a child's educational expenses.
The Coverdell shares some features with the Roth IRA, in that contributions are not tax-deductible, assets grow tax-free, and withdrawals are generally tax-free as well. However, Coverdell ESAs have restrictions on what the funds can be used for and on how long they can remain in the account.
Withdrawals from a Coverdell ESA are tax-free if are used for legitimate educational purposes. Eligible expenses include books, tuition, uniforms, computers, fees, and transportation for elementary, secondary, or university-level schooling.
If funds are used for a non-qualified expense, the account earnings are assessed a 10 percent penalty. Additionally, the earnings become taxable income to the beneficiary.
Subject to certain income limitations, anyone is eligible to contribute to a Coverdell account. This all-inclusive eligibility extends beyond parents and family members to corporations, trusts, and even the child himself.
Contributions to Coverdell accounts are limited to $2,000 annually per child. Even if a child has multiple accounts set up for her benefit, the cumulative contribution can still only equal $2,000. However, if you have more than one child, each child is entitled to her own $2,000 maximum contribution.
If your modified adjusted gross income exceeds a certain level, your contributions to a Coverdell might be limited. For married taxpayers filing jointly, contributions are prohibited if you have a modified adjusted gross income of more than $220,000 ($110,000 for any other tax filing status).
Contributions can be made to a Coverdell account until the beneficiary reaches age 18. Funds must be withdrawn and used for educational expenses before age 30. However, the beneficiary can be changed at any time to someone else who is not yet 30.
Control of Account
The IRS designates that a responsible person must control the account until the beneficiary reaches the age of majority, which is 18 in most states. The person in charge of the account directs the investments within the account and also disperses the funds until the beneficiary takes control.