The Coverdell ESA – or educational savings account – is a tax advantaged account which encourages people to set aside money to be used for future educational expenses. The funds placed in such an account grow tax deferred and can later be withdrawn tax free if they are used for appropriate educational expenses at an accepted educational institution.
Unlike some educational funds, such as 529 plans, Coverdell monies can be applied to elementary, secondary or college expenses.
Also in contrast to 529 plans, Coverdell accounts only permit a maximum contribution of $2000 per year, per child, regardless of how many ESAs have been opened for a specific individual. 529 plans have no limitations on the contributions other than the maximum lifetime contribution.
On the positive side, the monies within a Coverdell ESA can be invested in stocks, bonds and mutual funds whereas 529 funds can only be distributed among a limited number of state run allocation programs.
Coverdell ESA funds must be used by the time the individual in question is 30 years old, or they must be transferred to another family member who is below the cut off age. Additionally, these funds are not considered to be held by the child when applying for financial aid, which should increase the amount the child can qualify for, since parents are only expected to contribute 6% of their assets towards financing a college education while the child’s responsibility is 35%.
If it occurs that the distributions from a Coverdell ESA are higher than the expenses incurred then the gains are taxed.