All contributions must be made in cash, and are not deductible by the contributor.

 

No contribution can be made after the date on which such beneficiary attains age 18.

 

Except in the case of rollover contributions, no contribution can be accepted if it would result in the aggregate contributions for the taxable year per beneficiary exceeding $2,000.

NOTE: This dollar limitation does not apply to the amount that any one contributor may contribute, but rather to the total amount that can be contributed by one or more persons for the benefit of a single beneficiary.

Furthermore, the $2,000 per year contribution limit is itself phased out when an individual donor's adjusted gross income is between $95,000 and $110,000 (for a married couple, between $190,000 and $220,000).

 

Except in the case of a distribution made pursuant to death or divorce, the account balance must be paid over to the designated beneficiary when he or she attains age 30.

 

Requiring the payout to the designated beneficiary is a major difference with a Section 529 Plan, where the donor has the right to obtain a refund of the account funds.

 

Rollovers from one Education Savings Account to another benefitting the same beneficiary are permitted tax-free, as are transfers to another beneficiary, provided that such other beneficiary is a "member of the family" of the old beneficiary and has not attained age 30. The class of relatives constituting the family of the old beneficiary is the same as that applicable to Section 529 Plans.

Establishing a Coverdell Education Savings Account is similar to setting up a Roth IRA. Any bank, mutual fund company, or other financial institution that can serve as custodian of a retirement-oriented IRA is capable of serving as custodian of a Education Savings Account.

 

The cash contribution can be invested in any qualifying investments available through the sponsoring institution – stocks, bonds, mutual funds, certificates of deposit, etc. However, life insurance is not a permissible investment. There is no limit on the number of Education Savings Accounts that can be established for any one child (as long as the total contributions in any calendar year stay within the $2,000 limit).

Contributions to a Section 529 Plan and an Education Savings Account are permitted in the same year for the same beneficiary. There is no federal income tax on the earnings within the account, and the distributions will not be taxed as long as they do not exceed the student’s qualified educational expenses. Education Savings Accounts are not subject to gift tax or to estate tax on the death of a donor.

 

Distribution Rules. The distribution rules for Education Savings Accounts are similar but not identical to the rules applicable to Section 529 Plans. If distributions are not for qualified education expenses, the distribution will be included in the beneficiary’s taxable income. In that case, there is also the additional 10% tax on the amounts included in gross income, unless the distribution is made because of the death or disability of the designated beneficiary, or on account of a scholarship received by the designated beneficiary.

 

Tax-free withdrawals from Education Savings Accounts can also reduce the amount that the taxpayer might otherwise be able to claim as an above-the-line deduction.

Tuition, fees, academic tutoring, special needs services in the case of a special needs beneficiary, books, supplies, and other equipment that are incurred in connection with the designated beneficiary’s enrollment or attendance as an elementary or secondary school student at a public, private, or religious school.

 

Expenses for room and board, uniforms, transportation, and supplementary items and services (including extended day programs) that are required or provided by a public, private, or religious school in connection with such enrollment or attendance.

 

Expenses for the purchase of any computer technology or equipment, or services such as internet access and related services, if such technology, equipment, or services are to be used by the beneficiary and the beneficiary's family during any of the years the beneficiary is in school. (Such expenses do not include computer software designed for sports, games, or hobbies unless the software is predominantly educational in nature.)

Withdrawals from an Education Savings Account must be coordinated with Hope and Lifetime Learning credits as well as Section 529 Plans.

 

The definition of "qualified expenses" for purposes of taking tax-free Education Savings Account withdrawals is reduced by the tuition that is used to claim the Hope or Lifetime Learning credit. As a result, some portion of a withdrawal from an Education Savings Account can become taxable.

As discussed in the section below, under federal financial aid guidelines, an Education Savings Account will be treated as an asset of the beneficiary, not the owner.