Coverdell Education Savings Accounts

Coverdell Education Savings Accounts (CESAs), formerly known as Education IRAs, use a structure similar to that of a Roth IRA to allow for saving for education expenses. Accounts may be established on behalf of any child under the age of 18, and contributions of up to $2,000 per year may be made by anyone whose modified AGI is less than a certain threshold. For unmarried taxpayers, that threshold is $95,000 and for married taxpayers who file joint returns, the threshold is $190,000. The maximum allowable contribution phases down to zero over the next $15,000 of modified AGI for single taxpayers and $30,000 for married taxpayers filing joint returns. The income of the beneficiary is irrelevant to the calculation of allowable contributions.

Earnings accrue within the account tax-free and withdrawals are not taxed as long as they do not exceed qualified education expenses. Such expenses include tuition, fees, books, supplies, and equipment for elementary, secondary, or higher education. Room and board also qualify as long as the beneficiary is enrolled at least half-time. Qualified expenses are reduced, however, by tax-exempt scholarship and fellowship amounts as well as by any amount used to calculate either the Hope or lifetime learning credit.

Excess withdrawals are taxable to the extent that they exceed contributions, which effectively postpones rather than eliminates the tax on earnings. Most such withdrawals are also subject to a 10 percent penalty tax. If a plan loses money, the losses can potentially be claimed as itemized deductions, but only after all funds have been distributed. Once a beneficiary reaches age 30, all funds must either be distributed and taxed or rolled over into the account of a family member.