What is a Coverdell ESA?
A Coverdell ESA is like a special savings account designed to help families save for a child's education. According to the IRS, it's a “trust or custodial account set up in the United States solely for paying qualified education expenses for the designated beneficiary of the account.” Think of it as a dedicated fund to cover those school-related costs.
Setting Up a Coverdell ESA
There are a few key requirements to keep in mind when setting up a Coverdell ESA:
Age Limit: When you open the account, the beneficiary (the child) must be under 18 years old unless they are a special needs beneficiary.
Designation: The account must be officially designated as a Coverdell ESA when it's created.
Written Document: You'll need a written document that outlines the rules and guidelines of the account.
Contributing to a Coverdell ESA
If you meet the income requirements, you can contribute to a Coverdell ESA to help pay for the beneficiary's education expenses. Keep these points in mind:
Contribution Method: Contributions must be made in cash.
Non-deductible: Contributions aren't tax-deductible, so you won't be able to deduct them from your taxes.
Income Limits: Your modified adjusted gross income must be under a certain limit to be eligible to contribute. Check the IRS guidelines for the specific limits for the tax year.
Who Can Contribute? Individuals whose modified adjusted gross income is under the limit set for a given tax year can make contributions. Organizations, such as corporations and trusts can also contribute regardless of their adjusted gross income.
Contribution Deadline: You generally must contribute by the due date of your tax return (without extensions).
Contribution Limit: While a beneficiary can have multiple accounts, the total contributions to all Coverdell ESAs for one beneficiary can't exceed $2,000 in a year.
Using the Funds: Distributions
The best part? The beneficiary can generally receive tax-free distributions from a Coverdell ESA to pay for qualified education expenses.
Tax-Free Status: Distributions are tax-free as long as they don't exceed the beneficiary's qualified education expenses.
What if I withdraw more than the qualified education expenses?: If a distribution exceeds the beneficiary's qualified education expenses, a portion of the earnings is taxable to the beneficiary.
Age Restrictions: Any money remaining in the account has to be distributed within 30 days after the beneficiary turns 30. There's an exception for special needs beneficiaries.
Death Before 30: If the beneficiary passes away before age 30, the remaining funds must be distributed within 30 days of their death.
Family Transfers: Certain transfers to family members of the beneficiary are allowed.
Form 1099-Q
If you received distributions from a Coverdell ESA, expect to receive Form 1099-Q, “Payments from Qualified Education Programs (Under Sections 529 and 530)”, by January 31.
Want to Learn More?
For more details on contributions and figuring out the taxable portion of distributions, check out Chapter 6 of IRS Publication 970, Tax Benefits for Education. It's a great resource!