BOSTON (CBS) – When ESAs were created they were named Educational IRAs and limited to a $500 contribution. With a name change they became the Coverdell Education Savings Accounts or ESAs.
Currently these accounts can be set up for kids under 18 years of age and the annual contribution limit is $2000 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.
They have been very generous as to who is a qualifying family member. Could be the original beneficiary’s siblings, children, spouse, or even an ex-spouse. Almost anyone remotely related may qualify. 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.
If as a parent your income disqualifies you from setting up an ESA, someone else such as the grandmother can set it up for your child as long as the income requirements are met.
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 this year, K-12 expenses will no longer qualify and the annual contribution limit will revert to $500. Distributions will only be tax-free if you don’t claim a Hope or Lifetime credit in the same year.
If this happens and you already have an ESA consider moving the assets to the state’s 529 plan. There will be no tax penalties as long as they have the same beneficiary. But wait until the first of the year to see what kind of tax changes take place in December.
One more thing: For additional information on Coverdell ESAs, see Internal Revenue Service Publication 970.
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