If you plan to put away some money for the education of your children or grandchildren, a good place to start may be a Coverdell Education Savings Account (CESA).

You may set aside up to $2,000 a year for a designated beneficiary, under age 18, for use to cover qualified expenses for either qualified higher education or qualified elementary or secondary school. No contributions can be made to a Coverdell after the beneficiary reaches age 18, unless he or she has special needs.

Although the money you contribute is not deductible from your current taxable income, the account grows tax-deferred, and distributions used for qualified educational expenses are also tax-free.

A Coverdell account is one of two popular tax-advantaged college savings programs along with 529 education savings plans. (See: How to Choose a 529 College Savings Plan). Some parents also use Uniform Transfers to Minors Act accounts to help fund their children’s college education. (See more on UTMA accounts.) 

Who can contribute?

Any individual (including the beneficiary) can contribute to a Coverdell as long as their modified adjusted gross income (MAGI) for the year is less than $110,000, or less than $220,000 if filing a joint return. However, contribution limits are reduced with MAGI greater than $95,000 for single or $190,000 for joint filers.

Organizations, such as corporations and trusts, can also contribute to a Coverdell account, and may do so without income restrictions.

While several people can contribute to a Coverdell account for the same beneficiary in any given year, the total of all contributions cannot exceed $2,000. However, you may contribute up to $2,000 for several different beneficiaries in any one year. For example, if you have two children or grandchildren, you may contribute up to $2,000 for each of them, as long as the total contributions received by each child from all contributors is no higher than $2,000.

You should be aware, however, that the assets in a Coverdell plan will likely reduce the beneficiary’s eligibility for need-based financial aid. Assets held in any pre-paid tuition plans and college savings plans are treated as parental assets in the calculation of the expected family contribution toward college costs.

Where can you use Coverdell savings?

• Eligible postsecondary school. Your Coverdell savings may be used for any college, university, vocational school, or other postsecondary educational institution eligible to participate in a student aid program administered by the U.S. Department of Education. This includes virtually all accredited public, nonprofit, and proprietary (privately owned profit-making) postsecondary institutions. In fact, some educational institutions located outside the U.S. also qualify for Coverdell savings.
• Eligible elementary or secondary school. You may also use your Coverdell savings to pay qualified expenses at any public, private, or religious school that provides elementary or secondary education (kindergarten through grade 12), as determined under state law.

What types of expenses qualify?   

A Coverdell can be used to cover the following postsecondary education expenses:

• Tuition and fees.
• Books, supplies and equipment.
• Expenses for special needs services required by the beneficiary in connection with enrollment or attendance of an eligible school.
• Expenses for room and board for students who are enrolled at least half-time (half-time is defined as a student doing half the workload of a full-time student).
• The purchase of computer or peripheral equipment, computer software, or Internet access and related services if it is to be used primarily by the beneficiary while enrolled in school.

A Coverdell can be used to cover the following expenses for elementary and secondary students:

• Tuition and fees.
• Books, supplies, and equipment.
• Academic tutoring.
• Special needs services for a beneficiary with special needs.
• The purchase of computer technology, equipment, or Internet access and related services if used by the student and the student's family during any of the years the student is in elementary or secondary school.
• Room and board, uniforms, transportation, and supplementary items and services when specifically required by a school.

Note that the same expenses cannot be used for determining tax-free Coverdell account distributions and the American Opportunity or Lifetime Learning credits.

Are there any restrictions on Coverdell accounts? 

Generally, if you receive a distribution from a Coverdell account, it will consist of both your original contribution and earnings on that contribution.  If the distribution is not used for qualified educational expenses, you may pay federal (and possibly state) income taxes on the earnings, as well as an additional 10-percent tax penalty.

If the total distribution in a given year is more than the beneficiary's adjusted qualified higher education expenses¹, this is considered an excess distribution. The beneficiary would be assessed income taxes on the earnings of the excess distribution, as well as the 10 percent tax penalty, unless an exception applies. See IRS Publication 970 for more information.

Coverdell funds must be used by the age of 30 unless the beneficiary qualifies for a special needs exemption. Any funds not used by the age of 30 must be distributed within 30 days after the beneficiary turns 30, or the funds may be transferred to another family member under age 30. If the family member has special needs, the age restriction doesn’t apply. 

If the beneficiary dies before age 30, remaining assets must generally be distributed within 30 days after the date of death. However, the assets may also be transferred to the spouse or another family member who would not be required to withdraw the assets until he or she reaches age 30. If the beneficiary dies before age 30, remaining assets must generally be distributed within 30 days after the date of death. However, the assets may also be transferred to the spouse or another family member who would not be required to withdraw the assets until he or she reaches age 30.

A Coverdell plan is fairly quick and easy to set up, and it can give you a head start in preparing for the mounting educational expenses of your children or loved ones.

If you’re ready to take the next step, check out what a Coverdell account with Thrivent Mutual Funds has to offer.