A Coverdell Educational Savings Account (ESA) is a great wayf to save for your child’s college education because they offer great tax savings and you control how and where you invest your contributions. This is in contrast to a 529 college savings plan, in which investment options are limited to the options available in your state, or at the university in which you purchase the college savings plan.
Comparing Coverdell ESAs and 529 College Savings Plans. Before opening a Coverdell ESA account it is a good idea to investigate your options. Here is a 529 College Savings Plan and Coverdell ESA comparison, which can help you decide which college savings plan is best for your needs.
How to Open a Coverdell ESA Plan Account
Coverdell ESA plans can be opened at almost any brokerage firm or bank. You will need the SSN of the beneficiary to open the account as well as other personal information, including name, date of birth, address, and possibly other information, depending on where you open the account.
Coverdell ESA contributions can be invested in a wide range of investments, so the best course of action is to determine the type of investment that is appropriate for your needs, then find a broker, bank, or investment firm that can help you meet those needs. You will want to look at things such as:
- Fees. You want to minimize investment transaction fees, custodial fees, annual fees, or other fees
- Investment options. Do they offer mutual funds, index funds, stocks, bonds, CDs, etc.?
- Other account features. Can you link your account to a savings account, or other account, etc.
The Coverdell ESA works much like a Roth IRA, and at one point was called the Education IRA. Contributions are non-deductible and grow tax free. Withdrawals are also tax free for qualified higher education expenses. Some examples of qualified expenses include tuition and fees, books, supplies and equipment, and in many cases, room and board.
One feature that sets it apart from the 529 plan is the ability to use it for qualified expenses at any education level, including kindergarten to high school and post-secondary (college level), provided the school is eligible to accept Coverdell funds.
Coverdell ESA eligibility
The beneficiary of the Coverdell ESA must be younger than 18 at the time the contribution is made and the assets must be used or transferred to another beneficiary by the time he or she turns 30. There is no limit to how many accounts can be opened per person, however, the total annual contributions to the recipient cannot exceed $2,000 per year from all sources.
ESA Contribution and income limits
To be able to contribute the maximum amount, contributors must have an AGI lower than $95,000 for single filers and $190,000 for joint filers. Contribution limits are phased out for AGI levels between $95,000 – $110,000 for single filers and $190,000 – $220,000 for joint filers. To avoid the income limits and make the full contributions, you can gift the money to the minor and they can contribute it to their own Coverdell ESA.
Coverdell ESA withdrawals
Coverdell ESA withdrawals can be used for qualified expenses for students attending K-12 and/or higher education. Withdrawals are tax-free if used for qualified expenses, otherwise, the recipient may be required to pay early withdrawal penalties on the funds.
Use it, transfer it, or pay taxes
The money contributed to a Coverdell ESA is for educational use only, and you cannot withdraw your contributions for personal use (which differs from the 529 College Savings Plan). If the beneficiary does not use the assets in the Coverdell ESA by the time they turn 30, then there are two options for the money:
- Assets are automatically distributed and will be subject to taxes and penalties.
- Assets can be transferred to another relative.
Coverdell ESA accounts offer tax benefits but have some limitations
ESAs offer great tax benefits for college savings but they are somewhat more restrictive than the 529 College Savings Plan. The biggest downsides are the $2,000 per year maximum contribution and the requirement to use the assets by age 30.
Where to Open a Coverdell ESA Plan
In most cases, a mutual fund house or a discount brokerage firm will offer better options and lower fees than a local bank or credit union. Be sure to investigate all options before you open a Coverdell account.
Best Discount Brokerages to Open a Coverdell ESA Plan Account
Here are a few discount brokerage firms that offer Coverdell ESA plans with reasonable expenses:
Ally Invest (Formerly TradeKing). Ally Invest has been rated best overall discount broker and best in customer service by several authorities in the financial industry. They offer $4.95 trades, free trading and educational tools, free access to Maxit Tax Manager, and more.
Ally Invest account features: $4.95 stock trades, No custodial fees, no minimum balance, Read our Ally Invest Review (formerly TradeKing), or visit the Ally Invest website to Open an Ally Invest account.
TD Ameritrade: TD Ameritrade is a mainstay among the top-ranked online brokerage firms, as rated by notable companies, including Kiplinger’s and Barron’s. TD Ameritrade features an award winning trading platform, a top-notch eduction center, and one of the top rated research platforms.
TD Ameritrade Features: There are no account minimums, no monthly maintenance fees, and customers can make stock trades online, with their smartphone or tablet, over the phone with a broker, or at one of over 100 physical locations. For more information, check out our TD Ameritrade review, or to open a TD Ameritrade account, visit https://www.tdameritrade.com/.
E*TRADE. E*TRADE has won numerous industry awards. E*TRADE features a full scale bank along with its brokerage division. The bank / brokerage combination is an attractive if you prefer to do more of your banking and investing with one financial institution.
E*TRADE features: Full feature bank, $6.95 stock trades, no custodial fees with electronic statements, no minimum balance, and more. Please read our E*TRADE Brokerage Review for more information, or visit the E*TRADE website to Trade Free for 60 Days and Get up to $600 when you open an E*TRADE Account!
Other Places to Open a Coverdell ESA Plan Account
Mutual Fund Houses, banks, credit unions, and other options. Some large mutual fund firms also offer Coverdell Accounts. These may be good options, depending on which types of investments you choose to hold in your accounts. You can’t go wrong opening an account with the major firms like Vanguard, Fidelity, T. Rowe Price, Charles Schwab, and similar firms.
Many banks and credit unions may also offer these accounts. I recommend researching these options before investing with them. Many banks and credit unions do not offer as many investment options, and they may have slightly higher fees than you can find at some of the larger investment firms. In general, I find it is better to keep your investments at a dedicated investment firm – there are usually more investment options and lower fees.
Where Should You Open Your Coverdell ESA?
You can open a Coverdell ESA plan at a variety of locations. You may find it best to work with the investment firm that handles most of your current investments, or you may find it better to work with a new company if they offer better rates or investment options. As always, shop around for your needs.