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Guide to Education Savings Accounts & College Savings Plans


Education savings accounts (ESAs) offer a straightforward and efficient way to set aside funds for future educational expenses. These accounts, also known as Coverdell ESAs, are tax-advantaged savings vehicles that allow you to sock away $2,000 per beneficiary per year. That money can later be withdrawn tax-free to cover a range qualified educational expenses, from college tuition to elementary school tutoring.

If you need help saving and planning for future education expenses, consider connecting with a financial advisor.

What Is an Education Savings Account (ESA)?

An education savings account (ESA) is a savings tool designed to help individuals set aside funds for a variety of educational expenses. The ESA’s roots go back to the Taxpayer Relief Act of 1997, which introduced what was originally known as the education IRA. In 2001, it was renamed to honor Sen. Paul Coverdell, reflecting the government’s growing commitment to helping families cope with rising educational costs.

With an ESA, you can cover not only tuition but also other costs such as books, supplies and even computers. For special needs beneficiaries, meanwhile, ESAs can also cover expenses for services that support their educational journey.

ESAs offer tax-free earnings and withdrawals for a wide range of educational expenses and allow for a variety of investment choices, including stocks, bonds and mutual funds.

ESAs must be established before the beneficiary reaches age 18 and any funds remaining in the account must be withdrawn within 30 days of the beneficiary’s 30th birthday. However, these two requirements are waived for special needs beneficiaries.

How Much Can You Contribute to an ESA?

For 2024, the annual contribution limit for ESAs remains at $2,000 per beneficiary. This cap is not influenced by the number of accounts set up for a beneficiary but applies across all ESAs. For example, if you have two different ESAs established for one of your children, you can contribute up to a combined $2,000 across both accounts. The limit emphasizes the need for strategic planning to maximize the benefits of an ESA in preparing for a child’s educational future.

Are There Income Limits for ESA Contributions?

Yes, ESA contributions are subject to income limits. These limits are designed to phase out ESA eligibility for higher-income earners, ensuring that the tax advantages are targeted toward middle- and lower-income families.

In 2024, single filers can contribute the full $2,000 per account if their modified adjusted gross income (MAGI) is $95,000 or less. They can make a partial contribution if their income is between $95,000 and $110,000, at which point they lose the ability to contribute to an ESA.

Married couples filing jointly can make a full contribution in 2024 if their MAGI is $190,000 or less, and a partial contribution if its between $190,000 and $220,000.

Are ESA Contributions Tax-Deductible?

A father sits with his son and explains how saving for education expenses works.

Contrary to some beliefs, contributions to an ESA are not tax-deductible on federal income tax returns. This indicates that funds deposited into an ESA are derived from income that has already been subject to taxation, and thus, no immediate tax benefit is realized upon contributing to the account.

While federal tax relief is not granted at the time of contribution, it’s worth exploring state-level incentives that might offset this initial absence of a tax break. Keep in mind that state incentives are subject to legislative changes and may differ significantly from one state to another.

Despite the lack of federal tax deductibility for contributions. The two primary benefits associated with ESA accounts are tax-free growth and tax-free withdrawals for qualifying educational expenses.

  • Tax-free growth: Enables the investments within the ESA to accumulate without the immediate tax liability on earnings, which can include interest, dividends or capital gains.
  • Tax-free withdrawals: Disbursements used for qualified education-related expenses such as tuition, textbooks and certain housing costs are exempt from taxation.

Imagine a family that contributes $2,000 to their child’s ESA. Over the years, this investment grows to $3,000 without any tax drag. The additional $1,000 earned in the account can be withdrawn without any tax implications, provided it is used for eligible educational expenditures.

ESAs vs. 529 Plans

ESAs certainly aren’t the only tax-advantaged way to save for education expenses. 529 plans are another popular and effective way to sock away money for tuition, books and other other expenses. However, they possess distinct characteristics that set them apart. Here’s a comparison to clarify the similarities and differences between ESAs and 529 plans:

  • Contribution limits: ESAs offer a modest annual contribution limit of $2,000 per beneficiary, with contributions ceasing when the beneficiary reaches 18 years of age. In contrast, 529 Plans allow for much higher contributions, typically aligning with the annual gift tax exclusion amounts, which are up to $18,000 in 2024.
  • Age restrictions: The funds in an ESA must be used by the time the beneficiary turns 30, while 529 plans have no age restrictions for contributions or distributions.
  • Tax benefits: Contributions to an ESA are not tax-deductible, but earnings are not subject to tax, and distributions for qualified educational expenses are tax-free. Earnings in a 529 Plan also accrue tax-free, with qualified withdrawals remaining exempt from federal taxation.
  • Investment options: Both plans may include mutual funds and ETFs as investment options. 529 Plans may also offer age-based investment strategies that automatically adjust asset allocations as college approaches.
  • Qualified expenses: ESAs have a broader range of qualified expenses, including elementary and secondary education costs, whereas 529 Plans are traditionally more focused on post-secondary education expenses, though recent changes have expanded their use slightly.

Do ESAs Impact Financial Aid Eligibility?

A mother compares 529 plan options to an education savings account (ESA).

The Free Application for Federal Student Aid (FAFSA) determines a student’s financial aid eligibility. The FAFSA calculates the Expected Family Contribution (EFC), a figure that estimates a family’s financial strength and determines how much financial aid the student qualifies for. The lower the EFC, the higher the potential financial aid eligibility.

An ESA is considered an asset of the parent if the parent is the account holder, which is typically the case. This is beneficial because assets held by parents are assessed at a maximum rate of 5.64% in the EFC formula, as opposed to assets held directly by students, which are assessed at a rate of 20%. Thus, having an ESA can indeed affect your child’s financial aid eligibility, but the impact is less significant when the account is under a parent’s name.

Moreover, the distribution of funds from an ESA for qualified education expenses does not count as income for the student on the FAFSA. This distinction is crucial because income has a more substantial effect on financial aid eligibility than assets. Student income is assessed at 50%, meaning that every dollar of student income can reduce aid eligibility by 50 cents. Therefore, the strategic use of an ESA for paying educational expenses can mitigate its impact on financial aid.

Other College Savings Plans and Strategies

While Coverdells and 529 plans are popular savings plans, they may not be the perfect fit for every family’s unique financial picture. For this reason, exploring a variety of savings methods is crucial to crafting a personalized strategy that aligns with a family’s financial goals. By considering a mix of savings vehicles, parents and guardians can position themselves and their children for a smoother financial transition into the realm of higher education.

Here are three other ways to save and pay for college:

Prepaid Tuition Plans

Prepaid tuition plans can be a compelling strategy for parents looking to lock in tuition rates at today’s prices. The concept is simple: pay now for college credits that your child will use in the future, thereby avoiding the sting of tuition hikes. States that offer these plans provide a variety of terms, and it’s important for families to review their state’s offerings to understand the specific benefits and potential drawbacks.

UGMA/UTMA Custodial Accounts

The Uniform Gifts to Minors Act (UGMA) and the Uniform Transfers to Minors Act (UTMA) allow for the gifting of assets to minors, serving as a simpler alternative to trusts. These custodial accounts are versatile, allowing the funds to be used for various purposes beyond education, such as starting a business or buying a first home. Nevertheless, tax considerations, including the “kiddie tax,” can complicate matters, particularly when a child’s unearned income exceeds a certain threshold. Additionally, the fact that the child gains full control of the account upon reaching adulthood can be a double-edged sword.

Savings and Brokerage Accounts

Traditional savings accounts and taxable brokerage accounts can also be used for education savings, offering flexibility without the restrictions of education-specific accounts. However, these accounts do not offer the same tax advantages for education expenses.

State-Run Education Savings Accounts

A google search of the term “education savings account” will produce results for both Coverdell accounts and state-run education savings accounts. It’s vital to understand that they are not the same.

While Coverdell ESAs are federally-offered savings vehicles that are funded with a person’s own money, the state-run accounts are designed to provide eligible families with public funds for private school tuition, tutoring, homeschooling and other qualified expenses.

These state-run programs, available in states like Arizona, Arkansas and Florida, among others, offer another layer of educational funding options for families seeking alternatives to public schooling. The states currently offering these programs are:

  • Arizona
  • Arkansas
  • Florida
  • Indiana
  • Iowa
  • Mississippi
  • Montana
  • New Hampshire
  • North Carolina
  • South Carolina
  • Tennessee
  • Utah
  • West Virginia

Bottom Line

Education savings accounts (ESAs), also known as Coverdell ESAs, are a versatile tool that can help families save for qualified education expenses they may incur from as early as kindergarten to as late as college. However, they come with restrictions and considerations, such as contribution limits and age and income requirements, which necessitate careful planning and awareness. While ESAs provide a tailored fit for many, it’s essential to weigh them against other options like 529 plans, prepaid tuition plans and custodial accounts, which all have a specific set of features catering to diverse financial situations and goals.

Tips for Saving for College

  • When saving money in a 529 plan, it’s important to understand the difference between an individual account and a custodial account. The decision between these two variations can affect what happens to any money left over in the account after the child finishes college.
  • A financial advisor can help you save and plan for future education expenses, including your children’s college tuition. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.

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