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What is a Coverdell ESA?

Previously called an Education IRA, a Coverdell ESA is a trust or custodial account set up to pay for qualified educational expenses of the designated beneficiary.

Are there age restrictions for beneficiaries of Coverdell accounts?

A Coverdell account can be established for the benefit of a beneficiary under age 18. Once the beneficiary reaches 18, you may no longer contribute to the account. This age limit does not apply to a person with special needs.

If there are unused funds remaining in the account when the beneficiary reaches age 30, the funds must be withdrawn within 30 days. Again, the age limit doesn't apply to special-needs children. If the distributed funds exceed qualified education expenses, then part of the earnings included in the distribution is taxable in addition to a 10 percent penalty.

If you are unable to distribute the funds to the account beneficiary, you have another alternative. Unused funds can be rolled over into a Coverdell for another eligible family member of the beneficiary, or it may be maintained by changing the designated beneficiary. This person would also have until age 30 to use the funds for qualified education expenses.

How much can you contribute to a Coverdell account?

You may contribute up to $2,000 per beneficiary each year to a Coverdell ESA. The maximum $2,000 contribution limit is phased out for single filers with modified adjusted gross income, or MAGI, between $95,000 and $110,000, and for joint filers with between $190,000 and $220,000. No contribution is allowed once your MAGI reaches $110,000 for single filers and $220,000 for joint filers.

You have until the due date of your return (not including extensions) to make a contribution and have it apply to the previous year.

What are the tax benefits of a Coverdell?

Contributions are not tax-deductible, but the earnings grow tax-free and so do withdrawals as long as the distributions are used for qualified education expenses.

What expenses qualify for tax-free withdrawals?

For students attending eligible colleges, universities and vocational schools, qualified college expenses include tuition, fees, books, supplies and reasonable room and board for a beneficiary who is at least a half-time student. The funds in a Coverdell ESA can also be used to cover the costs of attending elementary and secondary school, kindergarten through grade 12. In addition to tuition, these costs can include uniforms, tutoring, computers, software and transportation.

Who can contribute to a Coverdell?

Any adult -- parents, grandparents, aunts and uncles or friends -- may contribute to a child's Coverdell account as long as his or her income falls within the guidelines. However, the total contribution from all sources cannot exceed $2,000 annually per beneficiary.

Can I also open a Section 529 Plan?

You can contribute to both a Coverdell account and a Section 529 Plan in the same year. Be aware that there may be gift tax implications if you give more than $11,000 per beneficiary.

How do I open a Coverdell account?

Any bank, brokerage firm or mutual fund company that handles traditional Individual Retirement Arrangements can help you set up and manage a Coverdell account. The money can be invested in stocks, bonds, mutual funds, or certificates of deposit. Consult with a CPA if you have additional questions about Coverdell savings accounts

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