Education Savings Account (ESA) Help

An ESA is a savings arrangement in which contributions are invested for the purpose of funding a student’s education. ESA contributions are not tax-deductible, but they may earn interest tax-deferred until distributed, but the child will not owe tax on any distribution from the account if it is equal to or less than the child’s qualified education expenses at an eligible educational institution for the year. Amounts distributed from an ESA that exceed the child’s qualified education expenses may be subject to income tax and to an additional 10 percent penalty tax. If the child does not need the money for education expenses, the assets may be rolled over or transferred to a qualified family member’s ESA or to a qualified tuition program (QTP).

The designated beneficiary of an ESA is the person on whose behalf the ESA has been established. The designated beneficiary must be under the age of 18 to receive contributions to the ESA, unless she qualifies as a special needs beneficiary.

Eligible taxpayers may deposit up to $2,000 per year into an ESA for a child under the age of 18. Parents, grandparents, other family members, friends, and even the designated beneficiary (child) may contribute to an ESA for the same child, but the total contributions for a child for a taxable year cannot exceed $2,000. Eligible taxpayers may contribute up to $2,000 for multiple children in a year.

Almost anyone can contribute to an ESA.

• Individuals of any age
• Individuals without earned income
• Individuals with modified adjusted gross income (MAGI) within the applicable limits for their tax filing status

There are two key limitations.

• Each child can receive up to the maximum contribution amount allowed per year ($2,000 per year) from all sources. It does not matter if this is done in a single account or in multiple accounts designed to benefit the same child.
• Contributors may be limited in how much they contribute if their MAGI exceeds $95,000 (for single filers) or $190,000 (for married tax filers). Above these income levels, the ability to contribute is phased out. An individual may not make an ESA contribution if her MAGI exceeds $110,000 for single tax filers or $220,000 for married tax filers.

A qualified education expense is one that is required for the enrollment or attendance by your child at an eligible educational institution.

These expenses include the following.

• Tuition
• Fees
• Books
• Supplies
• Equipment
• Academic tutoring
• Special needs services
• Room and board expenses
• Uniforms
• Transportation

Individuals can move assets from one ESA to a new or existing ESA through a transfer or a rollover. But with either type of movement, the assets must benefit the same child or qualified family member. A rollover or a transfer contribution does not affect the annual contribution limit. Individuals must complete rollovers within 60 days of the initial distribution and are limited to one from any of a designated beneficiary’s ESA.

Under the Heroes Earnings Assistance and Relief Tax (HEART) Act of 2008, individuals who receive military death gratuity payment or Servicemembers’ Group Life Insurance payments may roll over such amounts to an ESA (or a Roth IRA) without taxation. Individuals must roll over the payments within one year of receipt.

The responsible individual may change the designated beneficiary. Someone may wish to change the beneficiary if the current beneficiary has completed her education and there still are assets remaining in the account. The only requirement is that the new beneficiary must be a qualified family member.

Qualified family members include a designated beneficiary's

• child or descendent of child, stepchild, or eligible foster child;
• brother, sister, stepbrother, or stepsister;
• aunt or uncle;
• niece or nephew;
• parent, stepparent, or in-law (son, daughter, brother, sister, father, mother);
• spouse of any of the individuals named above; or
• first cousin.

Even with this extended range of family members, contributions only can be made for those under the age of 18.

ESA contributions must be made by the due date for filing the federal return for such taxable year, not including extensions (i.e., April 15). When this date occurs on a Saturday, Sunday, or a legal holiday, you have until the following business day to make a contribution.

If a designated beneficiary distributed more from her ESA than the cost of her qualified education expenses for the year, a portion of the distribution will be taxable to her. She must include the earnings attributable to the excess distribution in her gross income for the year, and pay a 10 percent penalty tax on the earnings amount, unless an exception applies (e.g., death or disability).

If the designated beneficiary does not use the ESA assets, or transfer or roll over the ESA assets to a qualified family member by age 30, the ESA is deemed distributed and is subject to taxation if not used for qualified educational expenses.

Talk to one of our representatives today to find out more about Coverdell education savings accounts. Our representatives may suggest that you seek additional information from a competent tax advisor.