BOSTON (CBS) – An ESA is another savings program for educational expenses. These accounts can be set up for kids under 18 years of age and the annual contribution limit is $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.
The money accumulated can be used for tuition, room & board, fees, supplies and equipment.
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 such as a sibling or a cousin as long as they are under 30.
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 grandma can set it up for your child as long as the income requirements are met.
Also, an ESA account is allowed to be used for a K-12 education as well as college and that could be a plus for some families planning private school for their kids.
An ESA can also be rolled into a 529 plan.
Let’s assume you start today when your little one is still in diapers. If you invest $2,000 a year 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.
The American Opportunity or lifetime learning credits can be claimed in the same year the beneficiary takes a tax-free distribution from an ESA, as long as the same expenses are not used for both benefits.
One more thing: For additional information on Coverdell ESAs, see Internal Revenue Service Publication 970.