What Are Education IRAs? Explaining Coverdell ESAs

A Coverdell Education Savings Account (ESA), formerly known as an Education IRA, is a tax-advantaged investment account designed to help families save for education expenses. It is established for a designated student, the beneficiary, to pay for qualified education costs. A primary feature is that funds can be used for not only college costs but also for qualified elementary and secondary school expenses. Distributions from the account, including any investment earnings, are tax-free when used for these purposes.

Eligibility and Contribution Rules

To establish a Coverdell ESA, the designated beneficiary must be under the age of 18 at the time the account is created. An exception to this age limit exists for beneficiaries identified as having special needs.

The ability for an individual to contribute is determined by their modified adjusted gross income (MAGI). For the 2025 tax year, single filers with a MAGI between $95,000 and $110,000 can make a partial contribution, while those with a MAGI below $95,000 can contribute the full amount. Individuals with a MAGI exceeding $110,000 are not eligible to contribute. For married couples filing a joint tax return, the income phase-out range is between $190,000 and $220,000.

The maximum annual contribution to a Coverdell ESA is $2,000 per beneficiary. This limit applies to the total amount received by the student, regardless of how many people contribute or how many separate accounts are in their name. For instance, if a parent contributes $1,500 to a child’s ESA, a grandparent can only contribute an additional $500 to any ESA for that same child that year. Contributions exceeding the $2,000 limit must be withdrawn before the tax filing deadline to avoid a penalty.

Contributions to a Coverdell ESA must be made in cash and are not tax-deductible at the federal level. The deadline for making a contribution for a tax year is the tax filing deadline for that year, not including extensions. These accounts are held at financial institutions like banks or brokerage firms, allowing funds to be invested in assets such as stocks, bonds, and mutual funds.

Distributions for Education Expenses

Withdrawals from a Coverdell ESA, known as distributions, are not subject to federal income tax as long as the total amount withdrawn in a year does not exceed the beneficiary’s adjusted qualified education expenses. The financial institution holding the account will issue Form 1099-Q to the beneficiary when a distribution is made.

Qualified expenses are separated into two categories, covering costs from kindergarten through postsecondary education.

Qualified K-12 Expenses

For elementary and secondary education, qualified expenses include:

• Tuition and fees at an eligible public, private, or religious school
• Academic tutoring and school uniforms
• Books, supplies, and other required equipment
• The purchase of computer technology, equipment, or internet access for the student’s educational use

Qualified Higher Education Expenses

For higher education, qualified expenses include:

• Mandatory tuition and fees at an eligible college, university, or vocational school
• Books, supplies, and equipment required for enrollment or attendance
• Room and board expenses, if the student is attending at least half-time

When a distribution is not used for qualified education expenses, the earnings portion of that withdrawal is subject to consequences. The beneficiary must include the earnings in their gross income for the year, where it will be taxed at their ordinary income tax rate. In addition to the income tax, the earnings are also subject to a 10% penalty tax.

Account Management and Rollovers

Any funds remaining in the account when the beneficiary reaches 30 years of age must be distributed within 30 days. This “age 30 rule” does not apply to beneficiaries with special needs. If the funds from this mandatory distribution are not used for qualified education expenses, the earnings portion will be taxable as ordinary income and subject to the 10% penalty.

To avoid the tax consequences of the age 30 rule, the account holder can change the designated beneficiary. The funds can be transferred to an eligible family member of the original beneficiary, such as a younger sibling or cousin, who is under the age of 30.

Another management strategy involves rollovers. Funds from one Coverdell ESA can be moved into another Coverdell ESA for the same beneficiary or an eligible family member without triggering taxes or penalties. Additionally, assets from a Coverdell ESA can be rolled over into a 529 plan for the same beneficiary.

Coordinating with Other Education Benefits

Coverdell ESAs and 529 plans both offer tax-free growth and withdrawals for education expenses, but they have distinct differences. Coverdell ESAs have a low annual contribution limit of $2,000 per beneficiary and income restrictions for contributors. In contrast, 529 plans allow for much larger contributions and have no income limits for contributors.

A family cannot use the same educational expenses to justify both a tax-free distribution from a Coverdell ESA and an education tax credit, such as the American Opportunity Tax Credit (AOTC) or the Lifetime Learning Credit (LLC). This is sometimes referred to as a prohibition against “double-dipping” on tax benefits.

To utilize multiple benefits, the expenses must be allocated. For example, if a student has $10,000 in tuition fees, the family could use Coverdell funds for one portion of the tuition. The portion of tuition that will be used to claim a tax credit must be paid for with other funds.