The Coverdell Education Savings Account or ESA was established to allow you another tax-friendly way to save for education expenses. One great thing about these plans are that they can be used to not only cover college expenses but certain qualified elementary and secondary school expenses as well.
And while contributions to the plan are not deductible, the deposited amounts grow tax free until distribution. Even then, the beneficiary won’t owe taxes as long as the distribution amounts are less than the qualified education expenses.
To qualify, the beneficiary must be under 18 years old. And while there are contribution limits each year, multiple family members can set up accounts for the same beneficiary as long as their combined contributions don’t exceed these limits.
There is some confusion about whether the ESA deductions are tax free when taken with a Hope or Lifetime Learning credit. But according to the IRS, these deductions can be taken tax free in the same year the Hope or Lifetime Learning credits are taken as long as the same expenses are not being used for both benefits.
In other words, you’re not allowed to “double dip” by taking multiple deductions on the same expenses.
These plans work similar to a Roth IRA but are designed to cover education expenses instead of retirement. However, unlike the Roth IRA or even the 529 Plan, distributions made to the ESA cannot be refunded back to yourself. They will be distributed to your child if not used for their education.
If there is a balance in the ESA when the beneficiary turns 30 it must be distributed within 30 days. The earnings portion will be taxed and subject to an additional 10% penalty. You can avoid this by rolling over the balance into an ESA account for another family member.
The Coverdell ESA is just one more way you can make your money work for you and save for your child’s education at the same time.From Coverdell ESA to Investing Money