BOSTON (CBS) – These were the Educational IRAs that had a name that made no sense. And at one time they were limited to a $500 contribution. They are now known as ESAs or Education Savings Accounts.
Today these accounts can be set up for kids under 18 years of age, and there is an annual contribution limit of $2,000 per child. The contribution is not tax deductible, but the earnings will accumulate tax-free and will remain tax free if used for education expenses.
If the money is not used for school, the earnings become taxable. The account is in the child’s name using his or her Social Security number and they have until they are 30 to use the money or it can be gifted to another eligible family member.
A qualifying family member is the beneficiary’s child, grandchild, stepchild, brother, sister, stepbrother, stepsister, nephew, niece, father, mother, grandfather, grandmother, stepfather, stepmother, uncles, aunt, first cousin, in laws and the spouses of these relatives except for the cousins. The beneficiary’s interest can also be transferred tax-free to a spouse or former spouse because of divorce. The new beneficiary must be under age 30 at the time of rollover.
The individual making the contribution on behalf of the child has income limitations to deal with. For taxpayers filing a joint return, their ability to make the contribution phases out with income between $190,000 to $220,000. For single taxpayers, it is $95,000 to $110,000.
As a parent, if your income disqualifies you from setting up an Education Savings Account, someone else such as grandma can set it up for your child as long as grandma meets the income requirements.
The $2,000 limit doesn’t sound like very much but it will help! Let’s assume you start today when your little one is still in diapers. If you invest for 18 years and we assume an 8% return on the money, there could be $75,000 in the account when the kiddo starts college and the money will be tax free if used for school expenses.
Currently the money in an ESA account is allowed to be used for a K-12 education as well as college. But unless Congress acts soon, some of these benefits expire next year (2012). K-12 expenses will no longer qualify and the annual contribution limit will revert to $500.
One more thing: For additional information on Coverdell ESAs, see Internal Revenue Service Publication 970.