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A Coverdell Education Savings Account (ESA) is a tax-advantaged way to set aside money for educational expenses, including those for primary, secondary, and higher education. You can open one in addition to a 529 college savings plan, or in place of one.
Generally speaking, an ESA has similar rules and benefits to a 529 plan, but more stringent income and contribution limits. ESAs offer more investment choices, however.
Key Points
• An Education Savings Account is a tax-advantaged account designed to help families save for qualified K-12 and college expenses.
• You can contribute a maximum of $2,000 per year for each student, regardless of how many accounts are opened for them.
• Eligibility to make contributions is determined by your modified adjusted gross income and tax filing status.
• Potential earnings grow tax-deferred and withdrawals are tax-free as long as the funds are used for qualified education costs.
• Any funds remaining in the account must be used or transferred to an eligible family member by the time the beneficiary turns 30.
Currently, SoFi does not offer ESAs.
What Is an Education Savings Account (ESA)?
An Education Savings Account is a type of custodial account that can be established to save money for qualified education expenses for students in grades K-12, as well as in college. ESA funds can be withdrawn to pay for tuition, textbooks, tutoring, and other education-related expenses.
Parents, grandparents, and other individuals can open educational savings accounts on behalf of an eligible beneficiary (the student) and make annual contributions. Contributions are limited to $2,000 per year, per beneficiary, though income levels impact eligibility for the full amount.
ESA Rules
If you’re looking to save for college or other education expenses, ESAs come with some specific rules:
• The beneficiary must be under 18 when the account is opened (or be a special needs beneficiary, per the IRS).
• Contributors must have an annual modified adjusted gross income (MAGI) below a certain level.
• It’s possible to contribute to an ESA and a 529 college savings plan for the same student.
How Do ESAs Work?
Education Savings Accounts work by allowing savers to contribute money for the benefit of an eligible student on a tax-advantaged basis. Contributions are not deductible, but they potentially grow tax-deferred, and withdrawals are tax-free when used for qualified education expenses.
Income Limits
Your income determines your ability to contribute to an ESA. You might be eligible to make a full contribution, a partial contribution, or no contribution at all.
Generally, full contributions are allowed for:
• Single filers with a modified adjusted gross income (MAGI) below $110,000
• Married couples filing jointly with a MAGI below $220,000
Partial contributions are allowed for:
• Single filers with a MAGI between $95,000 and $110,000
• Married couples filing jointly with a MAGI between $190,000 and $220,000
If you’re a single filer and have a MAGI greater than $110,000 or a joint filer with a MAGI greater than $220,000, you can’t contribute to an ESA.
Contribution Limits
The IRS is very clear about how much you can contribute to an ESA each year for each student. The annual contribution limit is $2,000. That limit applies per beneficiary, no matter how many educational savings accounts they have.
For example, if you open an ESA for your child and contribute $1,400, and the child’s grandparents also open an ESA for the same child, they could only contribute $600 for the same year.
Excess contributions in a given year may face a penalty of 6%, except under certain circumstances.
ESA Withdrawal Rules
Withdrawals from an ESA are tax-free when the money is used for qualified education expenses incurred at an eligible institution. A qualified education institution is any school that’s eligible to participate in federal student aid programs.
You can use ESA funds to pay for elementary school expenses, secondary school expenses, or college expenses. If you’re using an ESA for college savings, qualified higher education expenses include:
• Tuition and fees
• Books, supplies, and equipment
• Room and board, for students enrolled at least half-time
• Expenses for special needs services for a special needs beneficiary
Elementary and Secondary School Expenses
ESA funds can also be used to cover tuition and fees, books, supplies, equipment, academic tutoring, and special needs services at secondary or elementary schools. Room and board, uniforms, transportation, and supplementary items may also be covered if the school requires them as a condition of attendance.
Handling Leftover Funds
When the beneficiary of an ESA turns 30, any leftover funds must be withdrawn within 30 days or transferred to an eligible family member.
If the funds are not transferred to another ESA, the beneficiary will receive the funds, but may face some tax consequences. While the original contributions are not taxed, any growth or earnings on the account will be considered taxable income for the beneficiary. The potential earnings will also be hit with an additional 10% federal penalty tax because the funds were not used for qualified education expenses.
ESA Pros and Cons
Is an Education Savings Account a good way to save for education? There are advantages and drawbacks to consider if you’re trying to decide how to pay your child’s college tuition.
Advantages of ESAs include:
• Earnings potentially grow tax-deferred, and you can open an ESA as a supplement to other college savings plans.
• Qualified withdrawals are 100% tax-free and can be used for elementary, secondary, or higher education expenses.
• Should your student decide not to go to college, you can transfer their ESA to another beneficiary, but they must be under 30.
• ESA plans typically offer a wide array of investment choices.
Disadvantages of ESAs include:
• With a $2,000 annual contribution limit per child, you can only save so much with an ESA.
• Distributions for anything other than education expenses are subject to tax and penalties (including funds left over when the child’s education is complete).
• Excess contributions may face a 6% penalty.
• High-income earners may be ineligible to contribute to an ESA.
The deadline for withdrawals at age 30 can also be a disadvantage. With a 529 savings plan, you’re not required to take money out by a specific date or age, and you can roll unused 529 funds into a Roth IRA for the beneficiary tax-free and penalty-free (though this comes with strict limitations and rules).
ESA vs 529 Savings Plan
A 529 savings plan is another tax-advantaged way to save for college. You can also use up to $20,000 per student per year from a 529 plan to pay for expenses at public, private, or religious elementary and secondary school.
So, how does a 529 compare to an ESA? Here’s a quick side-by-side comparison.
| Education Savings Account | 529 College Savings Plan | |
|---|---|---|
| Who Can Contribute | Individuals whose MAGI is within IRS limits | Anyone, regardless of income |
| Annual Contribution Limit | $2,000 per child | There are no annual federal contribution limits. However contributions above the annual gift tax exclusion limit may trigger the gift tax.Each state sets an aggregate lifetime limit (typically $235,000 to $600,000+) on total contributions per beneficiary. |
| Eligible Beneficiaries | Students under the age of 18, or special needs students of any age | Any future student, regardless of age |
| Investment Options | Typically a wide array of investment choices | Typically limited or pre-set by the plan provider |
| Taxes on Withdrawals | Withdrawals for qualified education expenses are tax-free; all other withdrawals are subject to tax and penalties | Withdrawals for qualified education expenses are tax-free; all other withdrawals are subject to tax and penalties |
| Eligible Expenses | Withdrawals can be used to pay for qualified elementary, secondary, and higher education expenses | Withdrawals can be used to pay for qualified college expenses; up to $20,000 can be used per year for qualified K-12 expenses |
| Mandatory Distributions | All funds must be withdrawn by age 30, excluding special needs beneficiaries; funds can also be rolled over to another eligible family member | Funds can remain in the account indefinitely or be rolled over to another beneficiary; funds can also be rolled over into the beneficiary’s Roth IRA, subject to annual contribution limits and specific IRS rules. |
| FAFSA Impact | Treated as parental assets | Treated as parental assets |
The Takeaway
When considering a Coverdell Education Savings Account (ESA) for your child, it’s important to weigh the specific benefits and restrictions. An ESA offers a tax-advantaged way to save for K-12 and college expenses, featuring potential tax-deferred growth and tax-free withdrawals for qualified costs. However, with an annual contribution limit of $2,000 per beneficiary and income-based eligibility requirements, it is a more restrictive option than a 529 plan. In addition, funds must be used or distributed by the beneficiary’s 30th birthday. If you prioritize investment flexibility and have a lower annual savings goal, an ESA can be a powerful tool, but it’s wise to compare it against other options like 529 plans to ensure it aligns with your long-term financial strategy.
FAQ
How does an education savings account work?
A Coverdell Education Savings Account (ESA) allows you to contribute up to $2,000 annually per beneficiary under age . Your contributions potentially grow tax-free and you pay no taxes on withdrawals used for qualified education expenses. These expenses include tuition, books, and supplies from kindergarten through college. Anyone can contribute to the account, subject to income limitations. If you use funds for nonqualified expenses, you will face taxes and penalties.
Is an ESA the same as a 529?
No, a Coverdell Education Savings Account (ESA) and a 529 plan are different investment tools. Both offer potential tax-free growth and tax-free withdrawals for qualified education expenses. However, ESAs have a strict annual contribution limit of $2,000 per beneficiary and restrict eligibility based on your income. They also offer a wide range of investment choices. In contrast, 529 plans have much higher contribution limits, no income restrictions, and typically offer pre-set investment portfolios. ESAs offer more investment flexibility but lower savings potential.
What is the income limit for an ESA?
Eligibility to contribute to a Coverdell Education Savings Account (ESA) depends on your modified adjusted gross income (MAGI). Full contributions are generally allowed for single filers with a MAGI below $110,000 and married couples filing jointly with a MAGI under $220,000. If your income falls between $95,000 and $110,000 for single filers, or between $190,000 and $220,000 for married couples, you may be eligible to make partial contributions. If your MAGI exceeds these limits, you are ineligible to contribute to an ESA.
About the author
Rebecca Lake
Rebecca Lake has been a finance writer for nearly a decade, specializing in personal finance, investing, and small business. She is a contributor at Forbes Advisor, SmartAsset, Investopedia, The Balance, MyBankTracker, MoneyRates and CreditCards.com. Read full bio.
Photo credit: iStock/RyanJLane
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