What Are Coverdell Education Savings Accounts? - dummies

What Are Coverdell Education Savings Accounts?

You can invest money in Coverdell Education Savings accounts in a variety of ways: stocks, bonds, money market accounts, certificates of deposit, and so on, although you may not invest in life insurance policies.

Under the Coverdell rules (and unlike Section 529 rules), if you designate yourself the one responsible for all decisions on this particular account (also known as the responsible adult, who must be the parent or legal guardian of the minor child), you keep control of the money and make all the investment decisions for your child’s account. Over the years, the investments will (hopefully) earn significant income through interest, dividends, and capital gains, until the time that the account is closed.

Congress has put limits on who can contribute to Coverdell ESAs, based on annual income. If you make more than the phase-out limit allows, you can’t contribute to an account. If you find that your annual income excludes you from making contributions, don’t give up. If Coverdell is the way you want to save, a little careful planning can make it happen for you.

You pay no income tax on the income when it’s earned, and as distributions are made from these accounts to your designated beneficiary for qualified educational expenses, the income portion of the distribution is not taxed, either to you or to your student.

A Coverdell ESA must be opened as such, in writing, and you need to designate a beneficiary when you create it; you aren’t allowed to take an already existing account and decide that it’s now the Coverdell account for your student. Money that you contribute into the account is held by a trustee or a custodian, which must be a bank, mutual fund company, or any other entity that’s approved by the Internal Revenue Service (IRS).