Education Savings Accounts
Education savings accounts provide tax-advantaged ways to save for educational expenses. The two main types are Coverdell Education Savings Accounts (ESAs) and 529 Plans.
Coverdell Education Savings Account (ESA)
A Coverdell ESA provides tax-free growth for education expenses from elementary school through college.
Key Features
| Feature | Coverdell ESA |
|---|---|
| Annual Contribution Limit | $2,000 per beneficiary |
| Contribution Type | After-tax (not deductible) |
| Growth | Tax-free |
| Qualified Withdrawals | Tax-free |
| Eligible Expenses | K-12 and higher education |
| Age Limit for Contributions | Before beneficiary turns 18 |
| Age Limit for Distribution | Must use by age 30 |
Income Limits for Contributors
| Filing Status | Full Contribution | Phase-Out Ends |
|---|---|---|
| Single | < $95,000 | $110,000 |
| Married Filing Jointly | < $190,000 | $220,000 |
Qualified Expenses
Coverdell ESAs cover a broad range of expenses:
- Tuition and fees (K-12 through college)
- Books and supplies
- Room and board
- Computers and technology
- Special needs services
- Uniforms
Key Advantage: Unlike 529 plans, Coverdell ESAs fully cover K-12 expenses without annual limits.
Important Rules
- Multiple people can contribute (total $2,000/year per beneficiary)
- Beneficiary can be changed to family member under 30
- Unused funds must be distributed by age 30 (or rolled over)
- Non-qualified withdrawals: earnings taxed + 10% penalty
529 Plans (Qualified Tuition Programs)
529 Plans are state-sponsored education savings programs with higher contribution limits and no income restrictions.
Types of 529 Plans
| Type | Description |
|---|---|
| College Savings Plan | Investment account that grows based on market performance |
| Prepaid Tuition Plan | Locks in current tuition rates at specific schools |
Key Features
| Feature | 529 Plan |
|---|---|
| Annual Contribution Limit | No federal limit (gift tax applies over $18,000) |
| Lifetime Limit | Varies by state ($235,000 - $550,000+) |
| Income Limits | None |
| Growth | Tax-free |
| Qualified Withdrawals | Tax-free |
| K-12 Expenses | Up to $10,000/year |
| Age Limits | None |
Tax Benefits
| Level | Benefit |
|---|---|
| Federal | Tax-free growth and withdrawals |
| State | Many states offer tax deductions for contributions |
Qualified Expenses
529 plans cover:
- Tuition and fees (college)
- Room and board
- Books and supplies
- Computers and internet
- K-12 tuition (up to $10,000/year)
- Apprenticeship programs
- Student loan payments (up to $10,000 lifetime)
Gift Tax Considerations
| Contribution | Gift Tax Treatment |
|---|---|
| Up to $19,000/year (2025) | No gift tax reporting |
| $19,001 - $95,000 | Can elect 5-year gift averaging |
| Over $95,000 at once | 5-year averaging plus gift tax on excess |
Superfunding: Contributors can make up to 5 years of gifts at once ($95,000 in 2025) without gift tax consequences.
Non-Qualified Withdrawals
If funds aren't used for qualified education:
- Earnings taxed as ordinary income
- 10% penalty on earnings
- Principal (contributions) returned tax-free
Exceptions to Penalty
No 10% penalty if beneficiary:
- Receives a scholarship (withdraw up to scholarship amount)
- Attends a military academy
- Dies or becomes disabled
529-to-Roth IRA Rollover (2024+)
Starting in 2024, excess 529 funds can be rolled to a Roth IRA:
| Requirement | Detail |
|---|---|
| Account age | At least 15 years old |
| Lifetime limit | $35,000 maximum |
| Annual limit | Subject to Roth IRA contribution limits |
| Beneficiary | Must be in beneficiary's name |
Coverdell ESA vs. 529 Plan Comparison
| Feature | Coverdell ESA | 529 Plan |
|---|---|---|
| Contribution Limit | $2,000/year | No annual limit |
| Income Limits | Yes | No |
| K-12 Coverage | Full | $10,000/year |
| Age Restrictions | Yes (18/30) | No |
| Investment Options | More flexible | More limited |
| State Tax Benefits | No | Often yes |
ABLE Accounts (Achieving a Better Life Experience)
ABLE accounts help individuals with disabilities save without affecting government benefits.
Key Features
| Feature | ABLE Account |
|---|---|
| Eligibility | Disability onset before age 26 |
| Annual Contribution Limit | $19,000 (2025) |
| Asset Limit | $100,000 (for SSI purposes) |
| Qualified Expenses | Disability-related expenses |
| Tax Treatment | Tax-free growth and withdrawals |
Qualified Disability Expenses
- Education
- Housing
- Transportation
- Health care
- Financial management
- Assistive technology
- Basic living expenses
Choosing the Right Account
| If You Want... | Best Choice |
|---|---|
| Higher contribution limits | 529 Plan |
| Full K-12 expense coverage | Coverdell ESA |
| State tax deduction | 529 Plan (check your state) |
| More investment flexibility | Coverdell ESA |
| No age restrictions | 529 Plan |
| Coverage for disabilities | ABLE Account |
Key Takeaways
- Coverdell ESAs: $2,000/year limit, income limits, full K-12 coverage, must use by age 30
- 529 Plans: Higher limits, no income limits, K-12 limited to $10,000/year
- Both offer tax-free growth and qualified withdrawals
- Non-qualified withdrawals: earnings taxed + 10% penalty
- 529-to-Roth IRA rollover available starting 2024
- ABLE accounts help those with disabilities save
What is the annual contribution limit for a Coverdell Education Savings Account?
Which statement is TRUE regarding 529 plans?
If a 529 plan beneficiary receives a full scholarship, what happens to the funds in the account?
3.8 AML Rules
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