We’re continuing our education series with a closer look at Coverdell ESAs. Before 529 plans were expanded to include K-12 tuition, Coverdell ESAs were a popular way to save for both college and secondary education expenses.
Coverdells have both benefits and limitations, and it’s important to compare all of your saving options before opening an account.
First off, Coverdells can look very similar to 529 plans:
- Both provide tax-free withdrawals on qualified education expenses.
- Both have a low impact on financial aid eligibility.
- Both provide flexibility to adjust beneficiaries to another family member.
In addition, unlike 529 plans (and to their advantage) Coverdells have a more liberal definition of qualified education expenses. While 529 plans can only be used for tuition during kindergarten through twelfth grade to receive tax–free treatment; Coverdells can be used to purchase items like laptops or tablets and other supplies tax-free in those earlier years.
Annual contributions to Coverdells are limited to $2,000 per year, per beneficiary. In addition, contributions must be made before the beneficiary is age 18, and the account must be distributed before the beneficiary turns 30. These two restrictions make it extremely difficult to accumulate significant balances for college.
Furthermore, you’re not eligible to contribute to a Coverdell ESA if your modified adjusted gross income (MAGI) is above $110,000 for an individual and $220,000 for couples married filing jointly.
While a mix of both Coverdell and 529 savings could provide you with quite a bit of flexibility, there are also coordination rules for using these vehicles. The coordination rules state you can only use one of these tax-advantaged vehicles to pay for the same expense each year.
To learn more about education planning for your child or grandchild, reach out to your Relationship Manager at The Trust Company of Tennessee. To read our post on 529 plans click here.