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Coverdell Education Savings Account
A Coverdell Education Savings Account
is a tax-advantaged investment account in the United States designed to
encourage savings to cover future college education expenses. It is found at
section 530 of the Internal Revenue Code 26 U.S.C. ยง 530).
This account is named for its primary promoter in the U.S. Senate, the late
Senator Paul Coverdell (R-GA). The Coverdell education savings account is also known as an
Education Savings Account, a Coverdell ESA, a
Coverdell Account, or just an education savings account. Formerly it was known as
an Education IRA.
The Coverdell education savings account is
very similar to other education savings account which is known as the 529
savings plan. Like a 529 plan, the Coverdell education savings account allows
money to grow tax deferred and proceeds to be withdrawn tax free for qualified
education expenses at a qualified institution. However the definition of
qualified expenses in a Coverdell ESA includes primary and secondary
school, not just college and university as in the 529 savings plan.
Important differences of Coverdell Education Savings Account with
Section 529 plans
- Coverdell ESAs have lower contribution limits; currently $2,000 can be
contributed per year per child, while 529 plans generally have no
restrictions on contributions. Gift tax rules apply.
- Coverdell ESAs can allow almost any investment inside, including stocks,
bonds, and mutual funds, while 529 plans only allow a choice among a number
of state run allocation programs. The rules for investments allowed in ESAs
are the same as those for IRAs.
- Balances in a Coverdell ESA must be disbursed on qualified education
expenses by the time the beneficiary is 30 years old or gifted to another
family member below the age of 30 in order to avoid taxes and penalties;
there is no age limit for 529 plans.
- Coverdell education savings account allows withdrawing the money tax free for qualified
elementary and secondary school expenses; 529 plans do not.
- The income level of a donor may affect contributions into a Coverdell
ESA, but would not affect contributions to a Section 529 plan.
Important similarities of the Coverdell Education Savings Account with
Section 529 plans
- Money in both a Coverdell education savings account and a 529 plan is not considered the
child's (beneficiary's) money when applying for federal financial aid as
long as the owner of the account is someone other than the beneficiary, such
as a parent. This works to increase the child's potential financial aid
because parents are expected to contribute only around 6% of their assets to
finance college education, as opposed to the child's 35%.
- The custodian of both a Coverdell ESA and a 529 plan can designate a new
beneficiary without incurring taxes or penalties provided that the new
beneficiary is an eligible family member of the previous beneficiary.
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