What Are Coverdell Education Savings Accounts?

Formerly known as Education IRAs, Coverdell Education Savings Accounts (CESAs) are a means of saving up for your children's education expenses. Set up for anyone under the age of 18, the money from

If your modified adjusted gross income (MAGI) is less than $110,000 ($220,000 if filing jointly), you may be able to establish a Coverdell ESA to finance the qualified education expenses of a designated beneficiary. For most taxpayers, MAGI is the adjusted gross income as figured on their federal income tax return.

There is no limit to the number of separate Coverdell ESAs that can be established for a designated beneficiary. However, total contributions for the beneficiary in any year cannot be more than $2,000, not matter how many accounts have been opened. You also do not pay taxes upon withdrawing the money, although the initial contributions are not tax-deductible.

For anyone looking to set up education accounts that can grow and be used to meet the needs of their children throughout all their school years (not just college), this is a handy way to grow money tax-free. Elementary and middle school expenses, for example, might include books, school supplies, academic tutoring, and tuition for private schools.

Another plus of a Coverdell Education Savings Account is that, at this point, there are more investment options than the 529 College Savings Plans. This makes asset allocation easier.

Like all investment plans, there are some negatives. Besides a ceiling of $2,000 per annual investment, the assets are considered those of the child for whom the account is set up. This can affect his or her potential for receiving financial aid, since much of the qualification is based on the assets of the student applying.

Since the Coverdell accounts, like the 529 College Saving Plans, invest in stocks and mutual funds as part of their portfolio, there is a degree of risk. Therefore, you'll have to carefully choose a plan that meets your level of risk. Additionally, you'll have to evaluate the fees you need to pay. Since you're unable to invest larger sums of money, as you can with the 529 plans, the fees can take a more significant chunk out of your overall returns if you're not careful. Therefore, sit down and calculate rate of return, fees, and the benefits of a Coverdell (as you need to do with any investment) before jumping in and setting up such an education savings plan.