Five Mistakes to Avoid When Using a Coverdell ESA

According to The Private School Review, the average private elementary school tuition was almost $9,000 per student in 2016-2017. Private high school costs were closer to $15,000. While it’s a widely accepted fact that college isn’t cheap, the truth is that the rising cost of education isn’t limited to post-secondary schooling.

Coverdell Education Savings Accounts (ESA) are designed to help families pay for education. They offer tax-free earnings growth and tax-free withdrawals on qualifying expenses, but unlike 529 college savings plans, Coverdell ESAs aren’t just for college. You can use your Coverdell savings to pay your K-12 expenses too, making them a great option for families planning for primary and secondary education costs.

If you think a Coverdell ESA might be right for you, be sure to avoid these five common mistakes when opening your account.


  • Using a Coverdell Account as Your Primary Education Savings Plan


Coverdell ESAs have an annual contribution limit of $2,000 per student. If the student has multiple Coverdell accounts, no more than $2,000 can be deposited across all of the accounts. Because $2,000 can only stretch so far, it’s important not to rely solely on your Coverdell ESA for your education expenses. Roth IRAs and 529 plans are excellent savings tools that can supplement your Coverdell account. 


  • Ignoring the Age of the Beneficiary


Coverdell ESAs are targeted at students aged 18 or younger. If you continue to make contributions to the account after the beneficiary turns 18, those deposits will be subject to a six percent excise tax. On top of that, if there is any money left in the account when the student turns 30, it must be withdrawn within 30 days. After 30 days, the earnings portion will be subject to income tax and an additional 10 percent penalty tax. 


  • Disregarding the Changes to Your Financial Aid Eligibility


Contributing to a Coverdell ESA can negatively affect your student’s eligibility for financial aid. Similar to a 529 plan, up to 5.64 percent of the Coverdell account value will be included in the student’s Expected Family Contribution – if the account is owned by a parent or student. If the account is owned by someone else, like a relative or grandparent, your EFC won’t be affected, but any withdrawals from these accounts will be counted as student income on the following year’s FAFSA. 


  • Making Too Much Money


You are not eligible for a Coverdell ESA unless your adjusted gross income is less than $110,000 ($200,000 if you are filing jointly). Additionally, if your adjusted gross income is over $95,000, your ability to contribute $2,000 is reduced on a rateable basis. One way to contribute to a Coverdell ESA if your income is too high is by gifting the money to the student directly, who can then deposit the contribution into their own Coverdell account.


  • Spending Withdrawals on Non-Qualified Education Expenses


You only reap the benefits of a Coverdell ESA – like the tax-free growth and withdrawals – if the funds are used to pay for qualified education expenses, which vary depending on the level of schooling. Generally, the following costs are categorized as qualified education expenses:

  • Tuition and fees
  • Books, supplies, and equipment
  • Academic tutoring
  • Special needs services for a special needs beneficiary
  • Computer technology, equipment, or internet access and related services

Certain expenses, like room and board, uniforms, transportation, and supplementary items or services may need to be required by the school to be considered a qualified expense.

To learn more about the benefits of a Coverdell ESA and minimize your risk of falling victim to these pitfalls, contact our tax professionals.