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General IRA Product Information
Coverdell Education Savings Accounts (CESA)
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The Education IRA, a vehicle that allows individuals to save money for a child's education on a tax-favored basis was renamed the Coverdell Education Savings Account (CESA) on July 26, 2001, after the late Senator Paul Coverdell who championed their creation. Distributions used to pay for certain education expenses are free from federal income tax and any additional penalty tax.
At first glance, the CESA looks similar to Traditional and Roth IRAs. After all, higher education distributions are also permitted from these accounts. But there are two major differences between a CESA and the Traditional/Roth IRA. First, distributions for elementary, secondary and higher education expenses are allowed for a CESA whereas Traditional and Roth IRAs are limited to only higher education expenses. Second, while qualified higher education distributions from a Traditional or Roth IRA are penalty free, the same distribution from a CESA is penalty and tax free.
There are two eligibility considerations for a CESA. First, the child for whom you are contributing may not have had any contributions made on his or her behalf to a state prepaid tuition program in that year. Second, your modified adjusted gross income (MAGI) cannot exceed certain limits. There is no requirement that the contributor have earned income. Nor is there any requirement that the contributor be under the age of 70 1/2.
The total aggregate contribution into one or more CESAs on behalf of a child is $2000 for a taxable year. As a contributor, your allowable contribution depends on your MAGI. Your contributions to a CESA, however, are not aggregated with your Traditional or Roth IRA contributions. In other words, if you establish a CESA for a child, you can contribute a total of $3,000 to your Traditional or Roth IRA, as well as a $2000 contribution to a CESA on behalf of as many children as you wish.
A "child" is defined as a person who is under the age of 18. Contributions may be made on behalf of the child until the day before his or her 18th birthday. Contributions on behalf of an individual aged 18 or older are not permitted. However the age limit may be waived for children with special needs.
The law appears to allow contributors to deposit their maximum allowable contributions into CESAs for as many children as desired. There are no taxes paid on the earnings of a CESA. That's the best part of the CESA! Unlike a Traditional IRA, you cannot take a tax deduction for any of the contributions that you make to a CESA. However, when the beneficiary is ready to take his or her withdrawal for school, there are no taxes due on any of the interest that your money has earned.
The term "qualified education expense" means tuition, fees, books, supplies, and equipment required for the enrollment or attendance at an eligible elementary, secondary or higher education institution.
Distributions must be made during the year in which the education expense occurred. If distributions exceed the educational expenses, the additional amount withdrawn is a non-qualified distribution. A non-qualified distribution is any distribution other than an education expense distribution.
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All information contained herein is intended to act as a guide in giving you an estimate of your allowable contribution limit. Contact your tax adviser for further information. |
