Is A Coverdell ESA Right For You?
Is A Coverdell Education Savings Account Right For You?

Is a Coverdell Education Savings Account right for you? With so many college savings options, it’s hard to know which accounts to use. The first thing to realize is that the various accounts out there are not in competition with each other. In fact, they complement each other.

There are important differences between these accounts, but rather than trying to identify which one is best, it is important to focus on which one is right for you. Many times, the answer is a combination rather than one over the other.

Do Coverdell Education Savings Accounts Still Exist?

They most certainly do! The Coverdell ESA (Education Savings Account) can play a role in your education savings plan and should not be ignored.

Coverdell ESA assets can be used for both college and k-12 qualified expenses. 529 plans allow tax-free withdrawals for elementary and secondary school as well, but only for tuition up to $10,000.

A Coverdell ESA allows you to save for education expenses like you save for retirement in a Roth IRA. You won’t get a tax deduction for amounts you contribute but your withdrawals for qualified education expenses are tax free. The taxation is also similar to the 529.

Is a Coverdell ESA an IRA?

They are not IRAs although, you would be forgiven for thinking so. When they were originally introduced in 2002, they were known as an Education IRA. Calling them an IRA was a mistake since they were never intended for retirement.

Coverdell ESA Eligibility

Contributions to these accounts are limited by modified adjusted gross income (MAGI). The maximum income for joint and single filers is $190,000 and $95,000 respectively. For incomes beyond those amounts, contributions are reduced.

For joint and single modified AGI beyond $220,000 and $110,00 respectively, no contribution is allowed. View the tables below for details on determining how much you can contribute based on your filing status.

Coverdell ESA - Joint MAGI $200,000
Coverdell ESA – Joint MAGI $200,000

Coverdell ESA - SINGLE MAGI $100,000

Coverdell ESA – SINGLE MAGI $100,000

If you are getting aggressive early with your savings plan you will quickly max out your contribution to the ESA because the annual limit is $2,000. There are also income limits that need to be considered because you may not be eligible to contribute.

The good news is that you can have both an ESA and 529 plan at the same time. One strategy to consider is to fund an ESA up to the $2,000 limit and then contribute additional funds to a 529 plan.

A beneficiary of a Coverdell ESA must be age 18 or less. However, if the beneficiary is a “special needs beneficiary, the age requirement does not apply. In addition, there is no relationship requirement for contributions so you can set these up for multiple beneficiaries.

If the contribution to each does not exceed $2,000 (or reduced limit based on income) and you adhere to the age limit rules, you should be in the clear.

Coverdell ESA Tax Considerations:

It is important to be mindful of the Internal Revenue Service limits on contributions because the penalties for over-contributing can be significant. A 6 percent tax can be incurred on amounts that exceed the allowable contributions. In addition, that 6 percent penalty can be assessed each year the excess contribution remains in the account.

When you make contributions to a Coverdell ESA, there is no deduction allowed. While the funds are invested, there is no tax on capital gains or dividends and interest. This is known as “tax-deferred earnings.”

If the funds are used to pay for qualified educational expenses, the withdrawals will be tax free. For more information on the difference between these, please review my article titled TAX-DEFERRED VS TAX-FREE INVESTMENT ACCOUNTS.

Qualified Education Expenses:

Be mindful that qualified education expenses are reduced by amounts used for American Opportunity Credit or Lifetime Learning Credit.

Expenses must be incurred in an eligible educational institution. These include college, vocational school, university, other elementary, secondary, or post-secondary institution.

Qualified educational expenses are amounts paid for tuition, fees, and other related expenses for an eligible student.

Coverdell ESA - Qualified Education Expenses
Coverdell ESA – Qualified Education Expenses

Source: WebCE, Inc. Individual Retirement Accounts

If your children are very young and have several years until college, you may want to start your savings plan with an ESA. The primary reason is that it gives you an option to use the funds for K-12 expenses.

Let’s assume your child is 2 years old and you want to open an account to start saving for college. After all, the rising cost of college is usually what is top of mind. If you start with an ESA, you could access these funds for expenses related to K-12 if and when the need arises.

Funds in a 529 can only be used for college expenses with exception of k-12 tuition. By starting with an ESA, you are giving yourself greater flexibility to fund education expenses prior to college.

Coverdell Education Savings Account vs. 529 plan

Here are some similarities among these two plans:

  • Tax-free distributions
  • Must be used for an educational expense
  • You can change the designated beneficiary
  • Tax-free withdrawals for k-12

Here are some differences between ESAs and 529s:

  • Annual contribution limit of $2,000 compared to no limit for 529s
  • Coverdell accounts have income limits preventing those in a higher tax bracket from contributing.
  • There are age restrictions preventing a Coverdell ESA to be established for those under age 18.
  • Can be used for all k-12 school expenses, where 529 can only be used for k-12 tuition

Coverdell Education Savings Account Effect On Financial Aid

ESAs generally have favorable conditions in determining eligibility for financial aid. Similar to 529 plans, 5.64 percent is included in the student’s Expected Family Contribution. This is the case when the funds are owned by the student or parent.

Things are a little different if the Coverdell ESA funds are owned by a grandparent. In this scenario, nothing is reported until the tax-free distributions begin. When this happens, the amount received is reduced by 50 percent and then included in the Expected Family Contribution.

Beware of UTMA accounts. These can be problematic when for planning for college. UTMA accounts are often opened for minors by their parents or grandparents. Contributions made to these accounts are irrevocable gifts to the minor and may only be spent for their benefit. Unused funds in the UTMA account can negatively impact financial aid eligibility.

How do you open and contribute to an ESA?

A financial institution like Charles Schwab, Fidelity, or Vanguard offers these accounts. They can be opened online in a matter of minutes. Often, you can link a bank or credit union account and make monthly contributions.

While most investment firms will allow you to send checks for deposit, it isn’t the most efficient way to go. Rather than writing one big check at the end of the year, set up monthly contributions and set the account to dollar cost average into the mutual funds or ETFs of your choice.

What happens with a Coverdell ESA when child turns 18?

When the child turns 18, no more contributions to the account are allowed. However, there is an exception for those with special needs.

What if the beneficiary decides not to go to school?

There is always a possibility that an individual will choose not to go to school or further their education. Funds must generally be used by age 30. Whatever funds are not used within 30 days of the beneficiary turning 30 will be considered distributed and taxes will apply.

However, there is an opportunity to rollover Coverdell ESA funds to another beneficiary so long as that person is a member of the original beneficiary’s family.

How are Coverdell accounts invested?

Another positive for Coverdell Education Savings Accounts is the flexibility in investment options. Unlike 529 plans, you aren’t limited to a specific menu of mutual funds.

Depending on your risk tolerance and time frame, you can invest Coverdell ESA funds in individual stocks, exchange traded funds (ETF) and a host of other securities.

There is something to be said for a plain vanilla list of investment options. However, that may not suit all investors investment strategy.


As with all investment accounts, there are important income, gift, and estate tax considerations most of which have not been detailed here. However, if you’re looking to get started with an education savings plan, don’t overlook Coverdell ESAs.

They can play an important role in your education savings plan. Many people are turned off by the low annual limit of $2,000 and no immediate tax benefit via reduction in taxable income. Make no mistake, a little bit over a long period of time adds up to a lot!

The Coverdell ESA is often overshadowed by the mighty 529 college savings plan. After all, 529s allow for very sizable contributions. So high, in fact, that most people will never reach the annual limit. But we are all so focused on saving for college that we forget about education needs prior to that. Coverdell ESAs can help bridge the gap.

Have you considered how a Certified Financial Planner™ can help you?

Schedule a call with me via this link!

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  1. Great article describing similarities and differences between ESAs and 529s. Secure 2.0 Act indicates 529 accounts can be converted to Roth IRA if certain requirements are met. What about ESAs? Will the Secure 2.0 allow for ESAs to be converted to Roth IRA? Thanks.