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Making Education Costs Less Taxing: Coverdell Education Savings Accounts

Congress created “Education Individual Retirement Accounts” in 1997 to encourage savings for future education. Education IRAs were criticized as being both inadequate (only $500 could be contributed per year) and inappropriate (accounts were for education, not retirement; hence the name of the account seemed misleading). In response to this criticism, in 2001 legislation was passed changing many of the rules and regulations governing such accounts and renaming these accounts as Coverdell Educational Savings Accounts (CESA).

A CESA is a trust or custodial account created in the U.S. to cover “qualified education expenses” of a designated beneficiary. The account must be designated as a CESA when created and the beneficiary must be under age 18 or a “special needs beneficiary.” There must be a written document creating and governing the CESA, including provisions that:

  • The trustee or custodian must be a bank or entity approved by the IRS.
  • Contributions to the CESA must be in cash, made before the beneficiary reaches age 18 (unless the beneficiary has special needs), and contributions may not exceed $2,000 each year.
  • Money in the CESA may not be invested in life insurance contracts.
  • Money in the CESA may not be combined with other property, except in a common trust or investment fund.
  • The balance generally must be distributed within 30 days of the beneficiary reaching age 30, unless the beneficiary has special needs or if the beneficiary dies.

Qualified Education Expenses and Institutions

Amounts in a CESA grow tax free until distributed. Distributions may be tax free to the beneficiary, if they do not exceed the designated beneficiary’s “qualified education expenses.” The qualified expenses must be required for enrollment in an “eligible educational institution.”

Unlike other tax benefits for education, the CESA may be used for elementary and secondary school, as well as higher education. An eligible elementary or secondary school includes any public, private or religious school that provides an elementary or secondary education (kindergarten through grade 12) as determined under state law. Virtually all accredited, public, non-profit and private for-profit postsecondary institutions are eligible, provided the school is eligible to participate in a student aid program administered by the Department of Education.

Qualified Higher Education Expenses Include:

  • Tuition, fees, books, supplies, and equipment, if required for enrollment or attendance.
  • Expenses for a special needs beneficiary needed for enrollment or attendance.
  • Room and board, but only if the beneficiary/student is enrolled at least half time and the amount is the greater of: (1) the allowance for room and board, set by the school, included in the cost of attendance; or (2) the actual cost charged for residing in school-operated housing.
  • Any contribution to a “qualified tuition program.”

Qualified Secondary and Elementary Expenses Include:

  • Tuition, fees, books, supplies, equipment, tutoring, and special needs services for a special needs beneficiary, providing they are incurred for enrollment or attendance.
  • Room and board, uniforms, transportation, and supplementary items and services, providing they are required or provided by an eligible school, in connection with attendance or enrollment.
  • The purchase of computer technology, equipment or internet access and related services if used by the beneficiary and family while attending, subject to exceptions.

Contributions – Limits

Anyone, including the designated beneficiary, can contribute to a CESA. The maximum that can be contributed to one beneficiary (whether into one CESA or more) is $2,000, regardless of how many contributors there are. Contributors, however, must have modified adjusted gross income (MAGI) below specified amounts on individual and joint returns. There are no immediate tax advantages (e.g., deductions from income) for making a contribution to a CESA.

CESA’s are subject to a “phase out,” i.e., contributors with individual or joint MAGI within certain amounts may only contribute a fraction of the maximum. MAGI, as used here, represents gross income prior to itemized deductions, with the addition of certain other income not usually included in gross income for certain taxpayers, such as income earned abroad.


The designated beneficiary of a CESA may take distributions at any time, but such distributions must be less than the beneficiary’s qualified expenses for the year, adjusted by subtracting any tax-free assistance for the year, e.g., tax-free scholarships and fellowships, etc. If the distributions exceed the adjusted amounts, a portion of the excess (representing the untaxed increase in the CESA) is taxable to the beneficiary and may even be subject to a 10% additional tax under certain circumstances.

Tax laws also provide tax credits that may be taken under certain circumstances and by certain taxpayers for higher education expenses: the “Hope” and Lifetime Learning credits. Qualified education expenses must also be reduced by any expenses used as a basis for these credits when calculating tax-free distributions from the CESA.

Termination, Rollovers and Other Transfers

As noted, if the CESA is not used in full before the beneficiary dies or reaches age 30 (unless the beneficiary has special needs), money still on deposit must be distributed within 30 days. The law, however, provides liberal allowance for transfer (rollover) into another CESA or beneficiary redesignation, if the new beneficiary is a “family member” of the previous beneficiary. “Family member” is defined very broadly by the IRS to include immediate, step and extended family.

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