What is a Coverdell Education Savings Account (CESA)?
A Coverdell Education Savings Account, or CESA, is a trust or custodial account set up for paying qualified education expenses of a designated beneficiary. Contributions are made with after-tax dollars, and the earnings grow tax-free, provided they are used for qualified education costs such as tuition, books, and supplies. CESAs offer a flexible way to plan for a child’s education, from elementary through higher education, allowing for a variety of investments to potentially grow the savings.
While some refer to it as a Coverdell IRA, that’s actually a common misconception – this account is specifically designed for education savings, not retirement.
At Equity Trust Company, you can self-direct your CESA to invest in a broad range of asset classes, including real estate, precious metals, and more.
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Benefits of a Coverdell ESA
Why do some investors choose a CESA to save for education costs? Here are some of the reasons:
Education savings: A Coverdell ESA allows parents or families to set aside funds that can grow tax-free, provided they are used for qualified education costs. This includes tuition, books, supplies, and sometimes even room and board. Starting a CESA early can maximize the benefits of compounding interest, creating a fund to support the educational needs of the beneficiary from elementary through higher education.
Tax advantages: Contributions in a CESA are made with after-tax dollars and not tax-deductible, but the earnings grow tax-free within the account. Distributions from a CESA are also tax-free, provided they are used for qualified education expenses such as tuition, books, supplies, and other related costs.
Transferability: Funds in a CESA must be used by the designated beneficiary by age 30 or they will be subject to taxes and penalties in case of withdrawal. However, the funds in the account can be transferred to a different ESA to be used by or for a different qualified family member.
Investment flexibility: In addition to traditional investment opportunities, with a qualified custodian, you can expand your portfolio into alternative investments. This flexibility enables you to potentially enhance your returns while managing risk, ensuring that your educational savings grow effectively over time.
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Currently, contributions for a Coverdell ESA are capped at $2,000 per year, per child. You can contribute for the year all the way up until that year’s tax deadline.
For more CESA information, see IRS Publication 970.
CESA Eligibility Requirements
A CESA can be established for a beneficiary under the age of 18 or for an individual with special needs. A parent, grandparent, or other relative can open the account and designate the beneficiary. Once the account is opened, contributions can be made by anyone, including the beneficiary, parents, grandparents, relatives, and even corporations or organizations.
It is not required to have earned income to make contributions to a CESA.
CESA Rules
Understanding the rules that govern a CESA is key to making the most of this powerful tool for funding your child’s education.
Contribution limits: While the annual contribution limit is $2,000, these contributions can be made by multiple sources per year, such as individuals, relatives, or outside organizations. However, the total contributions must not exceed the annual limit. The same is true if the beneficiary has multiple accounts; contributions must not exceed $2,000.
Income limits: Eligibility to contribute to a Coverdell Education Savings Account (CESA) is subject to income limits. If your income exceeds certain thresholds, you may not be eligible to contribute to a CESA. Learn more about income limits here.
Age requirements: The beneficiary must be under the age of 18 when the account is established, except for those with special needs. Funds must be used by the time the beneficiary is 30, or they will face taxes and penalties when withdrawing funds.
Qualified expenses: To maintain tax-free status, CESA funds must be used for qualified educational expenses. These include tuition, fees, books, supplies, and equipment required for enrollment at eligible institutions. This covers primary, secondary, and higher education, including vocational schools. Room and board are also qualified if the beneficiary is enrolled at least half-time in a postsecondary institution.
CESA and Taxes
Contributions to a Coverdell ESA are made with after-tax income and are not tax deductible. The contributions, however, can then grow tax-free through potential profits from your investments like interest, dividends, or capital gains. When money is withdrawn to pay for qualified education expenses, it’s tax-free.
CESA and Withdrawals/Distributions
Distributions from a CESA are tax-free if used for qualified education expenses at eligible institutions. However, tax-free educational assistance like scholarships can affect this. If distributions exceed adjusted qualified expenses or are used for non-qualified expenses, they may be taxable and subject to a 10% penalty. For detailed rules, refer to IRS Publication 970.
CESA vs. 529: A Comparison
When it comes to saving for education, there are several account options available to help you plan for the future. Two of the most popular choices are the Coverdell ESA and the 529 plan. Both offer unique benefits and can play a vital role in funding your child’s education.
Here’s a chart that breaks down the key differences between the Coverdell ESA and the 529 plan, so you can determine which might be the best fit for your family’s needs.
| CESA | 529 | |
| Tax Advantages | Tax-free growth and withdrawals for qualified expenses | Tax-free growth and withdrawals for qualified expenses |
| Beneficiary Transfer | Account can be transferred to another family member of the beneficiary | Account can be transferred to another family member of the beneficiary |
| Contribution Limits | Annual contribution limits are capped at $2,000 per child | No federal limits on contributions; however, different states can set their own limits |
| Qualified Expenses | Can cover both K-12 and higher education tuition and expenses like books, fees, and supplies | Covers higher education tuition and expenses, apprenticeship and homeschool expenses, and student loan repayment |
| Penalties for Early Withdrawal | Earnings will be taxed as income plus 10% penalty on earnings | Earnings will be taxed as income plus 10% penalty on earnings |
| Investment Options | Open to both public (stocks, bonds, etc.) and with a qualified custodian, private (real estate, crypto, private equity, etc.) investments | Limited to the preset options offered by state |
| Age Restrictions | Cannot contribute to the account once the beneficiary reaches 18, and funds must be used by 30 | Most states have no age restrictions on when funds must be used |
| Income Limits | If your modified adjusted gross income exceeds $110,000 for single filers or $220,000 for joint filers, you are not eligible to contribute | No income limits |
| CESA | |
| Tax Advantages | Tax-free growth and withdrawals for qualified expenses |
| Beneficiary Transfer | Account can be transferred to another family member of the beneficiary |
| Contribution Limits | Annual contribution limits are capped at $2,000 per child |
| Qualified Expenses | Can cover both K-12 and higher education tuition and expenses like books, fees, and supplies |
| Penalties for Early Withdrawal | Earnings will be taxed as income plus 10% penalty on earnings |
| Investment Options | Open to both public (stocks, bonds, etc.) and with a qualified custodian, private (real estate, crypto, private equity, etc.) investments |
| Age Restrictions | Cannot contribute to the account once the beneficiary reaches 18, and funds must be used by 30 |
| Income Limits | If your modified adjusted gross income exceeds $110,000 for single filers or $220,000 for joint filers, you are not eligible to contribute |
Getting started with a CESA
Here are the three steps to getting started with an Equity Trust self-directed Coverdell ESA:
Open your Equity Trust CESA
One of our specialized IRA counselors can assist you, or you can do it online through our account management system myEQUITY.
Fund your new tax-advantaged account
There are three ways to fund your account: rollover, transfer, or out-of-pocket contribution.
Choose your investment and direct Equity Trust to send funds
Our myEQUITY team will walk you through submitting your investment online. One of will be assigned to assist you if you need help.
CESA FAQs
Where can you open a Coverdell Education Savings Account?
You can open a Coverdell Education Savings Account (Coverdell ESA or ESA) at financial institutions like brokerage firms, banks, or credit unions. Qualified custodians like Equity Trust offer you the chance to invest in alternative assets not available at traditional financial institutions previously mentioned.
Are Coverdell contributions tax deductible?
No, contributions made to a Coverdell ESA are not tax deductible; however, they do provide tax-free growth and are safe from capital gains and federal/state income tax while inside the account.
Are Coverdell distributions taxable?
Withdrawals or distributions taken from a CESA are not taxable if they are used for qualified education expenses. If used for any other purpose, any earnings will be taxed as income plus 10% penalty on earnings.
Is a Coverdell a 529 plan?
A Coverdell ESA is not a 529 plan. While both are tax-advantaged ways of saving for education, they have key differences such as contribution limits, qualified expenses, and investment options. A CESA offers more investment options in comparison to a 529.
Can a Coverdell be rolled into an IRA?
Funds from a CESA cannot be rolled into or transferred to a general retirement account like a traditional or Roth IRA. The funds must be moved to another CESA for the same beneficiary or a qualified family member. In some instances, it may be rolled into a 529 Plan.
What can Coverdell account funds be used for?
The funds in a CESA can be used for many education-related expenses. Some Coverdell ESA qualified expenses may include tuition and fees, books, supplies, computers, uniforms, and transportation.
Can a Coverdell be used to pay student loans?
No, a Coverdell ESA cannot be used to repay student loans. Coverdell ESAs are designed specifically to cover qualified education expenses, including elementary, secondary, and postsecondary education while attending the university, not expenses to be paid after attending.
Can a Coverdell be used for room and board?
Yes, a CESA could be used for room and board. For higher education room and board, it is a qualified expense if the student is enrolled at least part-time in the university. For primary and secondary education, room and board could be covered if it is required or provided by the school in connection with attendance or enrollment.
What happens to unused Coverdell funds?
Unused funds in a CESA may be transferred to a different CESA for the same beneficiary or a qualified family member. The funds could also be transferred to a 529 plan. If the funds are not moved or used by the beneficiary’s 30th birthday, the money will be taxed and distributed to the beneficiary.
Do Coverdells have an age limit?
A Coverdell ESA must be opened before the beneficiary turns 18, unless the beneficiary is an individual with special needs. The funds in the account must be used or transferred to a qualified account before the beneficiary turns 30, or they will face additional taxes and penalties when withdrawing funds, even for qualified expenses.
