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Coverdell Education Savings Accounts (CESA)

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Coverdell Education Savings Accounts are a great way to save money for a child's education.   The account acts much like a Roth IRA but with a shorter time-horizon.  Here are the main points:

  • Contribute after-tax dollars (just like a Roth IRA).
  • Contributions may be with income from any source (no earned-income rule).
  • Earnings in the account grow tax-free. 
  • Withdrawals are tax free if the money is used for a beneficiary's education expenses.
  • CESA accounts are held in the name of the beneficiary (usually a child).  
  • The account must be completely drained by the time the beneficiary reaches 30 years of age with one exception.
  • A beneficiary may be replaced if money remains in the plan (substitute beneficiaries must meet family definition).
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Extend Your Contribution Limit with a CESA

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Individuals may contribute to their Roth or Traditional IRA maximum and still make contributions to as many CESA plans as they want.  For example, a person with three children who has contributed the maximum amount to his own IRA may yet contribute a maximum of $2,000 to each child's CESA plan, for a total of $6,000.   There is no limit to the number of CESA accounts to which a person may contribute.

Contribution Timing:  Prior year contributions are allowed, just like other IRAs.  The deadline for a tax year 2006 contribution is the tax-filing deadline in April 2007. 

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CESA Contribution Limits

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decoration Tax Year Contribution Limits decoration
  2008 + $2,000.00  
decoration Limit is Per Beneficiary decoration

It is possible to open several different CESA accounts at several different banks in behalf of the same favored grandchild.  However, total contributions in behalf of that particular beneficiary may not exceed $2,000 in total from all sources.  Any contribution for the same beneficiary, regardless of where the CESA is held, is combined to arrive at the total contribution limit.

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Parties to CESA Plans

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There are three parties to a CESA:

  • The grantor or contributor - the person who contributes money to the CESA.  A person who contributes or grants money is not listed on the account unless he or she is also the responsible individual.
  • The designated beneficiary - the first person listed on the account, usually the child. 
  • The responsible individual - the second person on the account, usually a parent or guardian.

Tax reporting is under the child's TIN.  Anyone may be a contributor, but the responsible individual is the person who makes decisions and withdrawals.

A grantor (person making a contribution) does not appear anywhere on the account, nor on the paperwork unless he or she is also designated as the responsible individual.

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Income Restrictions

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CESA's are subject to MAGI (Modified Adjusted Gross Income) limits when determining eligibility to make contributions.  However, this is truly a ridiculous rule and impossible to enforce because contributions are reported under the beneficiary's SSN.   The IRS never knows who made the contribution.

The limits are shown below, although we can't enforce them for two additional reasons, (a) money for a contribution may be given to someone who is below MAGI limit, and (b) corporations or tax-exempt organizations who are not subject to income limitations may also make contributions. 

decoration Modified Gross Income Limitations for Single Filers  - Contribution limits decoration
  Below $95K At or between $95K - $110K Above $110K  
decoration Full Contribution Partial Contribution No Contribution decoration

decoration Modified Gross Income Limitations for Joint Filers  - Contribution limits decoration
  Below $95K At or between $95K - $110K Above $110K  
decoration Full Contribution Partial Contribution No Contribution decoration
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CESA Qualified Distributions

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Qualified educational expenses include just about any expense associated with elementary or secondary educational expenses. 

Higher education expenses include tuition, fees, books, supplies, and equipment required for enrollment or attendance at a college, university, vocational school, or post-secondary school. Reasonable room and board expenses are also included, but not to exceed $2,500 per year.  Qualified expenses for elementary and secondary schools are similar to those mentioned above.  A customer should review any specific questions with a tax advisor.

Withdrawals are tax and penalty free if distributions are for qualified educational expenses.  Taxes and a 10% penalty may apply if the distribution is taken for any other reason.

Distribution Deadline: funds from the CESA need to be distributed from the account by the time the beneficiary reaches 30 years of age. The only exception is a waiver for children with special needs (see a qualified advisor).