Shortcut Navigation:

Advantages and disadvantages of Coverdell education savings accounts

Advantages
  • Withdrawals that are used to pay the beneficiary's qualified education expenses are completely income tax free at the federal level
  • Qualified education expenses include elementary and secondary school expenses
  • You have complete freedom to choose the investments you put in the account
  • You can change the beneficiary without penalty if certain conditions are met
  • You can contribute to a 529 plan and a Coverdell ESA in the same year for the same beneficiary without triggering a penalty
  • A Coverdell ESA is considered an asset of the parent for federal financial aid purposes and assessed at a rate of 5.6 percent (distributions aren't counted as parent or student income)
Disadvantages
  • You can contribute a maximum of only $2,000 each year*
  • Your ability to contribute depends on your income--to make the full $2,000 contribution, single filers must have a modified adjusted gross income (MAGI) of $95,000 or less (a partial contribution is allowed if MAGI is between $95,000 and $110,000) and joint filers must have a MAGI of $190,000 or less (a partial contribution is allowed if MAGI is between $190,000 and $220,000)
  • Contributions aren't allowed after the beneficiary reaches age 18, unless the beneficiary has special needs
  • The account must be closed after the beneficiary reaches age 30, unless the beneficiary has special needs
  • Withdrawals from a Coverdell ESA that are not used for the beneficiary's qualified education expenses are taxed and penalized (the earnings portion of the withdrawal is subject to a 10 percent federal penalty and is taxed at the rate of the person who receives the withdrawal)
  • Depending on the financial institution, there may be fees associated with opening and/or maintaining the account

* The provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001 that raised the annual contribution limit for Coverdell ESAs to $2,000 will expire on December 31, 2010. Unless Congress extends the law, after December 31, 2010, the annual contribution limit for Coverdell ESAs will revert to $500, the limit in effect prior to January 1, 2002.