What Are Education Savings Accounts?

Education Savings Accounts (ESAs), also recognized as Coverdell Education Savings Accounts, offer a versatile and tax-advantaged way to save for education. These accounts present a valuable tool for families planning their children’s educational future, especially for educational expenses from kindergarten through graduate school.

The Appeal of ESAs: Benefits and Flexibility

Tax Advantages

One of the most attractive features of an ESA is its tax benefit. Contributions themselves are not tax-deductible; however, the earnings in the account grow tax-free. When it comes time to withdraw funds for educational expenses, these withdrawals are also tax-free, provided they are used for qualified costs.

Qualified Expenses

ESAs cover a broad range of educational expenditures. This includes tuition, fees, books, supplies, and even room and board under certain conditions. For students in K-12, this can also extend to uniforms, transportation, and computers.

Control Over Funds

A key aspect of ESAs is the control they offer. The account holder, typically a parent or guardian, has the authority over investment decisions and distributions. This level of control ensures that funds are managed according to the specific needs and goals of the beneficiary’s educational journey.

Comparing ESAs and 529 Plans

While ESAs are robust in their offerings, they might sound awfully similar to 529 plans. They are indeed similar but there are some nuances:

Investment Choices in ESAs

With ESAs, account holders can choose from a variety of options like stocks, bonds, mutual funds, and ETFs. 529 plans do not offer this level of flexibility and pre-package most of their investment options. With more options and control, you can build your portfolio how you like to meet your individual risk tolerances and financial objectives.

Contribution Limits

529 Plans are often favored for their higher contribution limits, with some states allowing contributions exceeding $300,000, and no income restrictions for contributors.

Beneficiary Rules

1. Limited Beneficiary Changes: The ability to change the beneficiary of an ESA is more limited compared to 529 plans. The new beneficiary must be a family member of the original beneficiary and under the age of 30. This can include siblings, but the definition of a family member is not as broad as in 529 plans.
2. Age Limit for Use of Funds: Funds in an ESA must be utilized by the time the beneficiary reaches 30 years old. If the funds are not used, they could be subject to taxes and penalties, unless rolled over to another eligible family member’s ESA.
3. Contribution Age Limit: Contributions to an ESA are only allowed until the beneficiary turns 18, barring special needs situations.

Qualifying for an ESA

Your ability to contribute to an ESA depends on your modified adjusted gross income (MAGI). For full contributions, single filers must have a MAGI under $95,000, and joint filers under $190,000. Contributions phase out at higher income levels, reaching a complete phase-out at $110,000 for single filers and $220,000 for joint filers.

Final Thoughts

ESAs can be helpful for those who have prefer to personalize their investments but this comes with a lot more maintenance (keeping up with rules and making sure you are setup to still be able to use it). If you do want to give ESAs a shot, I recommend doing the following:

• Create a solid roadmap for your child's education. Account for plans if they decide not to go for post-secondary education.
• Plan out your career growth. If you start an ESA but end up not qualifying for it in a few years because your income has grown above the limit. It might not be worthwhile.

If ESAs might not be a good fit for you, definitely take a look at 529 plans to consider. For education savings, it's always better to start sooner than later to maximize the tax-free growth.